Going back to camp for my 2nd ICT. Happy that i'll get to see old friends and it is also a nice break from my internship. For a week, i'll get to sleep early and get disconnected from the wired world. Except for my very reliable Nokia camera-less phone, i have no access to the outside world.
Looking forward to read the 2 books i've brought in, and maybe watch a few more episodes of Friends on my ipod thanks to Ryan who converted the videos to make it ipod ready.
I'm also going to listen again to Warren Buffett's MBA talk which lays the foundation of my investing philosophy. So much to do over the next 5 days.
to Ajalumnichoir - we've ushered in a new era. Thank you to those who have served the choir so well over the past few years, especially Pei Ying, for working hard for us despite being seriously sleep deprived. And to our new team, i look forward to another exciting year under you all, new blood, new ideas, new challenges, same old love for music. What would i do without all my choir people...
Sunday, June 29, 2008
Wednesday, June 25, 2008
Simple portfolio and on compounding
Over the past few days different people have discussed with me some investing related topics. I think that the more i talk to people, the more i realise that getting "average return" for most people is a very hard thing to do. The heart wrenching feeling of watching your investments from your hard earned savings getting halved is too great a pain to bear. Thus most people buy when everyone is buying, and sell when everyone is selling (feeling safety in numbers), inadvertly causing disappointing performance.
I think that for some people, simply buying an insurance plan that has not much hidden expenses is a good way to save for retirement. It is not that insurance plan are great investment, but the fact that people can't access daily quotations save them a lot of pain and that you are lock into the plan for the long term also forces people to stay the course. If lower investment return and higher expense is what it takes to instill dicipline in people to save for their retirement, then so be it.
For those that have the ability to control their emotions when it comes to investing, i still think that have a simple portfolio plan that is low cost and then sticking to it is the most optimal way to save for a comfortable retirement. Zhao Bin sent me this article last week and it think its advice is both sound and timely. I especially like David Swensens's portfolio, but it is expensive to create such a portfolio in singapore. I've applied largely the Dr. Bernstein's No-Brainer portfolio for the portfolio i manage for my parents. Over the past 3 years, the results have been fairly decent.
I think that for most of us, active stock picking should be more of a hobby (hopefully not an expensive one) than to think to get rich through that. And unless you are diligent enough to find those companies that you truly understand, have great economics (as Andrew said, those that 'shit cash' year after year), and purchased at a inexpensive price, it is most likely a foolish to think that we can do significantly better than long term market average.
On Compounding (and on how to become a millionaire...at a rather old age)
We have all learnt arithmetic and geometric series in our secondary school days. To get really rich, we HAVE to engage in geometric return type of activity.
I've shared the following example with many of my friends from E.y.E. Investment Club.
A) Boi boi started teaching tuition at 18, and makes $800 a month. He invested every single cent into an stock index fund and does this for 4 years. And once he reached the age of 22, he stopped the plan and never touched the money in the fund ever again. So the total amount of money invested is $38,400. Boi boi retired at the age of 60.
B) Mr I'm-so-smart, is great at studying and and finally managed to get a PhD by the age of 28. He is now a chemist employed at a big oil firm earnings 10k a month. He realised the importance of saving and started saving $10,000 every year for the next 31 years before he retired at the age of 60. The total invested amount $310,000.
At 10% compounded return, guess who will be richer when they retire?
a) boi boi who invested $38k by the age of 22
b) Mr I'm-so-smart who invested a grand sum of $310k.
The answer is...as most of you would have guessed, Boi boi!
By the age of 60, (old) Boi boi would have accumulated $1,833,148 and Mr I'm-so-smart $1,819,434.
The main difference is that Boi boi invested about one tenth of what Mr I'm-so-smart did and ended up ahead.
Morale of the story: START COMPOUNDING EARLY!
and yes, anyone younger than me stand a way better chance at beating me in the game of compounding. So i'll strike back by either compounding at higher rate of return, or i'll stay in the compounding game longer - Outwit . Outplay . Outlast
Anyone who's interested in the spreadsheet used to arrive at the above numbers just drop me an email. It quite fun to see how total retirement sum is affected by years of compounding, invested capital and rate of return.
I think that for some people, simply buying an insurance plan that has not much hidden expenses is a good way to save for retirement. It is not that insurance plan are great investment, but the fact that people can't access daily quotations save them a lot of pain and that you are lock into the plan for the long term also forces people to stay the course. If lower investment return and higher expense is what it takes to instill dicipline in people to save for their retirement, then so be it.
For those that have the ability to control their emotions when it comes to investing, i still think that have a simple portfolio plan that is low cost and then sticking to it is the most optimal way to save for a comfortable retirement. Zhao Bin sent me this article last week and it think its advice is both sound and timely. I especially like David Swensens's portfolio, but it is expensive to create such a portfolio in singapore. I've applied largely the Dr. Bernstein's No-Brainer portfolio for the portfolio i manage for my parents. Over the past 3 years, the results have been fairly decent.
I think that for most of us, active stock picking should be more of a hobby (hopefully not an expensive one) than to think to get rich through that. And unless you are diligent enough to find those companies that you truly understand, have great economics (as Andrew said, those that 'shit cash' year after year), and purchased at a inexpensive price, it is most likely a foolish to think that we can do significantly better than long term market average.
On Compounding (and on how to become a millionaire...at a rather old age)
We have all learnt arithmetic and geometric series in our secondary school days. To get really rich, we HAVE to engage in geometric return type of activity.
I've shared the following example with many of my friends from E.y.E. Investment Club.
A) Boi boi started teaching tuition at 18, and makes $800 a month. He invested every single cent into an stock index fund and does this for 4 years. And once he reached the age of 22, he stopped the plan and never touched the money in the fund ever again. So the total amount of money invested is $38,400. Boi boi retired at the age of 60.
B) Mr I'm-so-smart, is great at studying and and finally managed to get a PhD by the age of 28. He is now a chemist employed at a big oil firm earnings 10k a month. He realised the importance of saving and started saving $10,000 every year for the next 31 years before he retired at the age of 60. The total invested amount $310,000.
At 10% compounded return, guess who will be richer when they retire?
a) boi boi who invested $38k by the age of 22
b) Mr I'm-so-smart who invested a grand sum of $310k.
The answer is...as most of you would have guessed, Boi boi!
By the age of 60, (old) Boi boi would have accumulated $1,833,148 and Mr I'm-so-smart $1,819,434.
The main difference is that Boi boi invested about one tenth of what Mr I'm-so-smart did and ended up ahead.
Morale of the story: START COMPOUNDING EARLY!
and yes, anyone younger than me stand a way better chance at beating me in the game of compounding. So i'll strike back by either compounding at higher rate of return, or i'll stay in the compounding game longer - Outwit . Outplay . Outlast
Anyone who's interested in the spreadsheet used to arrive at the above numbers just drop me an email. It quite fun to see how total retirement sum is affected by years of compounding, invested capital and rate of return.
Galadriel to Frodo...
Galadriel: You are a Ring-bearer, Frodo. To bear a Ring of Power is to be alone.
[pulls out her hand]
Galadriel: This is Nenya, the Ring of Adamant. And I am it's keeper. This task was appointed to you, and if you do not find a way, no one will.
Frodo: I know what I must do, it's just that... I'm afraid to do it.
Galadriel: Even the smallest person can change the course of the future.
[pulls out her hand]
Galadriel: This is Nenya, the Ring of Adamant. And I am it's keeper. This task was appointed to you, and if you do not find a way, no one will.
Frodo: I know what I must do, it's just that... I'm afraid to do it.
Galadriel: Even the smallest person can change the course of the future.
Monday, June 23, 2008
You never know what you are capable of...
Had a nice long chat with Ivan today. He shared his exploits from his Eurotrip with me and i'm truly facinated by both his experiences over there and that he managed to spend a GRAND sum of about $5,000 on a 31 day trip.
He travelled to countries like Austria, Italy, Germany, England, France, Czech Republic and a few more. He planned an innovative route to fly to England (via brunei and dubai) and saved himself a hundreds dollars. Along the way the gets to meet a fun company of travel mates and experienced things that was 'showcased' in Eurotrip the Movie. (hopefully not the one that involves a really huge battery operated toy...u'll get it if you've watched the show)
He encouraged me to go on my exchange and see beyond our sunny island. And also not to get tunnel vision and miss out all the life that is happening around us. So wise. I really admire his openess to experience and willingness to embrace the big unkown. Partly inspired by him, I've submitted my international exchange application today! hope i get it.
--------------------
Reading David Novak's book for the past 2 days. He's the CEO of YUM! Home to KFC, Pizza Hut, Taco Bell and A&W. He tells the story of how he grew up in a trailer park, how he became a marketing guy, and his rise to being the CEO of the company. There's 2 main takeaway from the book;
1) Give recognition to those around you. How many times have you felt overworked and underappreciated? Have you felt the warm feeling when you've done a good job and people recognise and thank you for that?
Human being yearns to be acknowledged. Giving recognition is totally different from paying lip service. Giving praise when you think the other person doesn't deserve it makes you a phony. But if you can find that ONE thing that he did well and you thank him for that, you are acknowledging his strong points, and that may be the ONLY thank you he gets for the day. He'll remember it.
2) You never know what you are capable of. How can a trailer park kid ever dream of being the head of one of the largest restuaruant chain in the world at the young age of 47? He kinda of stumbled upon it.
David Novak takes risks that few dared to take. Like asking outright to be the chief of YUM when Pepsico decided to spin it off. Or when he attached a corny poem behind his resume that landed him his first job with an advertising agency. He believed in stretching yourself, and learning from the best in the field. I really liked their "founding truth". So i've attached it below.
On advice given to young people starting out? Find where your passion lies, for that's the time you'll be able to walk the talk, take responsibility for both yourself, your company, and those around you.
"I tap dance to work, and when I get there, I think I’m supposed to lie on my back and paint the ceiling. It’s tremendous fun.” Warren Buffett
Saturday, June 21, 2008
Ryan, the oracle of Bishan
Was talking to Ryan in J8 today. I asked him which fast food chain would he want to own if he could own the whole company. He said McDonald's.
Next i asked if he can own any company in the world, which one will he own? He said Apple.
Then i asked if he has to own the company for the next 50 years, which one will he choose? He chose McDonald's as he's more certain that it will be around for the next half century.
Let's see how ryan would have done if he had bought these 2 stocks 4years ago.
Assume a equally weighted portfolio of 500 dollars each, over the last 4 years, the porfolio would have grown from $1,000 to $10,143 (excluding dividend). A staggering 78.5% return annualized!!!
$1,000 invested in the S&P 500 would have grown to 1360, a respectable 8% annualized.
So Ryan's portfolio would have beaten the index by over 10 times!!! Whoohoo!!!!
My numbers may not be very accurate, for i've simply pulled it off from google finance.
Click link to see the stock chart.
Of course investing is by NO MEANS as simple as buying Apple and McDonald's and get rich. But if you stick with investing in good companies that you know (i'm quite sure ryan will beat most Apple stock analyst in terms of product knowledge) and did not grossly overpay for the stock, the odds of you being a successful investor is rather high.
Loh Wei does NOT understand the economics of Apple, but i do think i know somethings about YUMS! (KFC, longjohnsilvers n pizza hut), McDonald's, Johnson and Johnson, Pepsico and/or Coke. And i'm confident that they'll be around for the next quater of a century. Most likely bigger and stronger.
Psst psst, next time if we need a stock idea, let's see what's Ryan spending his money on...
Next i asked if he can own any company in the world, which one will he own? He said Apple.
Then i asked if he has to own the company for the next 50 years, which one will he choose? He chose McDonald's as he's more certain that it will be around for the next half century.
Let's see how ryan would have done if he had bought these 2 stocks 4years ago.
Assume a equally weighted portfolio of 500 dollars each, over the last 4 years, the porfolio would have grown from $1,000 to $10,143 (excluding dividend). A staggering 78.5% return annualized!!!
$1,000 invested in the S&P 500 would have grown to 1360, a respectable 8% annualized.
So Ryan's portfolio would have beaten the index by over 10 times!!! Whoohoo!!!!
My numbers may not be very accurate, for i've simply pulled it off from google finance.
Click link to see the stock chart.
Of course investing is by NO MEANS as simple as buying Apple and McDonald's and get rich. But if you stick with investing in good companies that you know (i'm quite sure ryan will beat most Apple stock analyst in terms of product knowledge) and did not grossly overpay for the stock, the odds of you being a successful investor is rather high.
Loh Wei does NOT understand the economics of Apple, but i do think i know somethings about YUMS! (KFC, longjohnsilvers n pizza hut), McDonald's, Johnson and Johnson, Pepsico and/or Coke. And i'm confident that they'll be around for the next quater of a century. Most likely bigger and stronger.
Psst psst, next time if we need a stock idea, let's see what's Ryan spending his money on...
Friday, June 20, 2008
Investing in Property and Casualty insurance business (P&C)
This post is written to remind me of what to look out for when investing in P&C companies. Charlie Muger cautioned that for most of us, we will often miss out things if we don’t use a check list. Thus I’ve created a ‘checklist’ in the second part of the post for companies to pass before I would purchase them.
-------------------------------
What is P&C?
Property/casualty insurance is insurance on homes, cars, and businesses. Technically, property insurance protects a person or business with an interest in physical property against its loss or the loss of its income-producing abilities. Casualty insurance mainly protects a person or business against legal liability for losses caused by injury to other people or damage to the property of others.
(source: http://www.iso.com/index.php?option=com_content&task=view&id=12&Itemid=399)
The Checklist
1. Combined Ratio should be low.
2. Expense Ratio should be low if they are a low cost competitor (who issnt?)
3. Loss Ratio should be low, but not artificially manufactured by under-reserving. Warren Buffett talks about the buried suit problem. If a family buried their deceased in a rented tux, the bills will arrive long after the person dies.
4. Cost of Float if positive (ie UNprofitable underwriting) should be low compared to risk free government yield. If it is negative, then people are providing capital to the firm to invest at cheaper than free rate.
5. Book value (adjusted for distributed earnings) gives a good indication of historical growth rate of intrinsic value.
6. Investment performance determines the long term prosperity of many firms
7. P&C firms NEED to have extraordinary financial strength (indicators: net debt to total capital & liquid asset to potential claims)
8. Insiders should be significant shareholders due to the buried suit problem. In the insurance industry, due to the long tail liabilities , companies with heavy insider ownership have a greater incentive to think long term and engage only in profitable underwriting.
This and That
Managerial talent matters a lot in this industry as most firms have inherently no moat / competitive advantage. Superb underwriter combined with superb investor and low overhead promises a potential bonanza for investors.
Be ready to accept the underwriting cycle. A few years of profitability will attract new entrants ready to do business at any price, thus pushing premium to unacceptably low level. When catastrophe happens, weaker firms gets wiped out and industry goes back to profitability. The industry has generated high underwriting profit and prices have soften considerably over the past 2 years, have lower expectation in the near term.
See the following quote on an example of strict underwriting discipline.
From OdysseyRe’s 2007 Annual Report
“As the market becomes more challenging, we will respond by heightening OdysseyRe’s commitment to disciplined underwriting. Shareholders can expect us to purposefully contract our business in response to the deteriorating climate.”
Andrew A. Barnard,
President and Chief Executive Officer
OdysseyRe
Due to the fat tail, (imagine Katrina, 911 and Sichuan Earthquake happening in a same place at the same time), invest in insurer who have a good knowledge of what they are insuring (think Buffett or Ajit Jain). If not, stick with insurers that underwrites events that falls in a normal curve, auto accidents, fire accidents, property, etc (GEICO, Progressive, Chubbs).
On the previous point of importance of insider share ownership, see the recent ouster of AIG’s CEO Martin Sullivan which has lost discipline in investing and capital structure vs. previous CEO Hank Greenberg (one of AIG’s largest shareholder) who has kept debt low, kept expenses low, and generated good underwriting profit and growth for decades.
Other examples include Markel (80+% of shareholders are employees), Berkshire Hathaway (Buffett + Munger…duh), and Fairfax Financial Holdings (Canadian investor Prem Wasta).
Appendix
-Cost of float is calculated by dividing Underwriting profit / (loss) by float.
-Definition of Float (from Buffett’s 2001 letter)
To begin with, float is money we hold but don’t own. In an insurance operation, float arises because premiums are received before losses are paid, an interval that sometimes extends over many years. During that time, the insurer invests the money. This pleasant activity typically carries with it a downside: The premiums that an insurer takes in usually do not cover the losses and expenses it eventually must pay. That leaves it running an "underwriting loss," which is the cost of float. An insurance business has value if its cost of float over time is less than the cost the company would otherwise incur to obtain funds. But the business is a lemon if its cost of float is
higher than market rates for money.
…we have calculated our float..by adding net loss reserves, loss adjustment reserves, funds held under reinsurance assumed and unearned premium reserves, and then subtracting insurance related receivables, prepaid acquisition costs, prepaid taxes and deferred charges applicable to assumed reinsurance.
-------------------------------
What is P&C?
Property/casualty insurance is insurance on homes, cars, and businesses. Technically, property insurance protects a person or business with an interest in physical property against its loss or the loss of its income-producing abilities. Casualty insurance mainly protects a person or business against legal liability for losses caused by injury to other people or damage to the property of others.
Commercial Lines
-automobile
-businessowners (property and liability combined for smaller commercial customers)
-capital assets (output policy)
-crime and fidelity
-electronic commerce
-employment-related practices liability
-equipment breakdown (formerly boiler and machinery)
-farm
-financial institutions
-general liability
-inland marine (diverse commercial goods and properties)
-management protection
-market segments
-medical-professional liability
-package policies (property and liability combined)
-property
-umbrella
-workers compensation
Personal Lines
-automobile
-dwelling property
-homeowners (property and liability combined)
-inland marine (diverse personal goods)
-personal liability (including personal umbrella)
(source: http://www.iso.com/index.php?option=com_content&task=view&id=12&Itemid=399)
The Checklist
1. Combined Ratio should be low.
2. Expense Ratio should be low if they are a low cost competitor (who issnt?)
3. Loss Ratio should be low, but not artificially manufactured by under-reserving. Warren Buffett talks about the buried suit problem. If a family buried their deceased in a rented tux, the bills will arrive long after the person dies.
4. Cost of Float if positive (ie UNprofitable underwriting) should be low compared to risk free government yield. If it is negative, then people are providing capital to the firm to invest at cheaper than free rate.
5. Book value (adjusted for distributed earnings) gives a good indication of historical growth rate of intrinsic value.
6. Investment performance determines the long term prosperity of many firms
7. P&C firms NEED to have extraordinary financial strength (indicators: net debt to total capital & liquid asset to potential claims)
8. Insiders should be significant shareholders due to the buried suit problem. In the insurance industry, due to the long tail liabilities , companies with heavy insider ownership have a greater incentive to think long term and engage only in profitable underwriting.
This and That
Managerial talent matters a lot in this industry as most firms have inherently no moat / competitive advantage. Superb underwriter combined with superb investor and low overhead promises a potential bonanza for investors.
Be ready to accept the underwriting cycle. A few years of profitability will attract new entrants ready to do business at any price, thus pushing premium to unacceptably low level. When catastrophe happens, weaker firms gets wiped out and industry goes back to profitability. The industry has generated high underwriting profit and prices have soften considerably over the past 2 years, have lower expectation in the near term.
See the following quote on an example of strict underwriting discipline.
From OdysseyRe’s 2007 Annual Report
“As the market becomes more challenging, we will respond by heightening OdysseyRe’s commitment to disciplined underwriting. Shareholders can expect us to purposefully contract our business in response to the deteriorating climate.”
Andrew A. Barnard,
President and Chief Executive Officer
OdysseyRe
Due to the fat tail, (imagine Katrina, 911 and Sichuan Earthquake happening in a same place at the same time), invest in insurer who have a good knowledge of what they are insuring (think Buffett or Ajit Jain). If not, stick with insurers that underwrites events that falls in a normal curve, auto accidents, fire accidents, property, etc (GEICO, Progressive, Chubbs).
On the previous point of importance of insider share ownership, see the recent ouster of AIG’s CEO Martin Sullivan which has lost discipline in investing and capital structure vs. previous CEO Hank Greenberg (one of AIG’s largest shareholder) who has kept debt low, kept expenses low, and generated good underwriting profit and growth for decades.
Other examples include Markel (80+% of shareholders are employees), Berkshire Hathaway (Buffett + Munger…duh), and Fairfax Financial Holdings (Canadian investor Prem Wasta).
Appendix
-Cost of float is calculated by dividing Underwriting profit / (loss) by float.
-Definition of Float (from Buffett’s 2001 letter)
To begin with, float is money we hold but don’t own. In an insurance operation, float arises because premiums are received before losses are paid, an interval that sometimes extends over many years. During that time, the insurer invests the money. This pleasant activity typically carries with it a downside: The premiums that an insurer takes in usually do not cover the losses and expenses it eventually must pay. That leaves it running an "underwriting loss," which is the cost of float. An insurance business has value if its cost of float over time is less than the cost the company would otherwise incur to obtain funds. But the business is a lemon if its cost of float is
higher than market rates for money.
…we have calculated our float..by adding net loss reserves, loss adjustment reserves, funds held under reinsurance assumed and unearned premium reserves, and then subtracting insurance related receivables, prepaid acquisition costs, prepaid taxes and deferred charges applicable to assumed reinsurance.
Wednesday, June 18, 2008
Marc Andreessen / Charlie Munger
Stumbled upon the Marc Andreessen's blog. He is the founder of Netscape and numerous venture capital firm. Surprised that he's also a fan of Charlie Munger.
He has a great post on the application of Charlie's very famous "The Psychology of Human Misjudgement" talk, as applied to the business world.
If you have the time, do read his advice on career planning. It got me thinking hard about what i should do from now till i graduate.
Whitney Tilson's notes from Wesco's shareholder meetings 2008 is truly worth reading a few times over. Charlie Munger commented on Singapore's success and the relevance of our founding FATHER.
Charlie also commented on his need for "glorious independence". I think i need to achieve that too, for that the insecure child within me yearns for success...hoping to be heard one day. .. ... .... ... .. .
Tuesday, June 17, 2008
Buffett's Big Bet
I am a huge fan of index funds. Although investors in Singapore have to pay a relatively higher costs than US investors, it still handily beats many of the high cost funds promoted by banks and 'financial advisors'.
The following is an excerpt from Fortune Magazine, written by Carol Loomis (Fortune's Editor at Large, Buffett's friend and editor of his annual letters to shareholders.
----------------------------------
(Fortune Magazine) -- Will a collection of hedge funds, carefully selected by experts, return more to investors over the next 10 years than the S&P 500?
That question is now the subject of a bet between Warren Buffett, the CEO of Berkshire Hathaway, and Protégé Partners LLC, a New York City money management firm that runs funds of hedge funds - in other words, a firm whose existence rests on its ability to put its clients' money into the best hedge funds and keep it out of the underperformers.
You can guess which party is taking which side.
Protégé has placed its bet on five funds of hedge funds - specifically, the averaged returns that those vehicles deliver net of all fees, costs, and expenses.
On the other side, Buffett, who has long argued that the fees that such "helpers" as hedge funds and funds of funds command are onerous and to be avoided has bet that the returns from a low-cost S&P 500 index fund sold by Vanguard will beat the results delivered by the five funds that Protégé has selected.
We're way past theory here. This bet, being reported for the first time in this article (whose author is both a longtime friend of Buffett's and editor of his chairman's letter in the Berkshire annual report), has been in existence since Jan. 1 of this year.
It's between Buffett (not Berkshire) and Protégé (the firm, not its funds). And there's serious money at stake. Each side put up roughly $320,000. The total funds of about $640,000 were used to buy a zero-coupon Treasury bond that will be worth $1 million at the bet's conclusion.
That $1 million will then go to charity. If Protégé wins, it has asked that the money be given to Absolute Return for Kids (ARK), an international philanthropy based in London. If Buffett wins, the intended recipient is Girls Inc. of Omaha, whose board includes his daughter, Susan Buffett.
(see full article here)
The Arguments
Prediction: Over a 10-year period commencing Jan. 1, 2008, and ending Dec. 31, 2017, the S&P 500 will outperform a portfolio of funds of hedge funds, when performance is measured on a basis net of fees, costs, and expenses.
Warren Buffett: AGREE
A lot of very smart people set out to do better than average in securities markets. Call them active investors.
A lot of very smart people set out to do better than average in securities markets. Call them active investors.
Their opposites, passive investors, will by definition do about average. In aggregate their positions will more or less approximate those of an index fund.
Therefore the balance of the universe - the active investors - must do about average as well. However, these investors will incur far greater costs. So, on balance, their aggregate results after these costs will be worse than those of the passive investors.
Costs skyrocket when large annual fees, large performance fees, and active trading costs are all added to the active investor's equation. Funds of hedge funds accentuate this cost problem because their fees are superimposed on the large fees charged by the hedge funds in which the funds of funds are invested.
A number of smart people are involved in running hedge funds. But to a great extent their efforts are self-neutralizing, and their IQ will not overcome the costs they impose on investors.
Investors, on average and over time, will do better with a low-cost index fund than with a group of funds of funds
Investors, on average and over time, will do better with a low-cost index fund than with a group of funds of funds
Protégé Partners LLC: DISAGREE
Having the flexibility to invest both long and short, hedge funds do not set out to beat the market. Rather, they seek to generate positive returns over time regardless of the market environment.
For hedge funds, success can mean outperforming the market in lean times, while underperforming in the best of times.
Through a cycle, nevertheless, top hedge fund managers have surpassed market returns net of all fees, while assuming less risk as well. We believe such results will continue.
There is a wide gap between the returns of the best hedge funds and the average ones. This differential affords sophisticated institutional investors, among them funds of funds, an opportunity to pick strategies and managers that these investors think will outperform the averages.
Funds of funds with the ability to sort the wheat from the chaff will earn returns that amply compensate for the extra layer of fees their clients pay.
Monday, June 16, 2008
The Pleasure of Finding Things Out
I’m reading Richard Feynman again. He’s really quite amazing, for he’s a scientist who’s brilliant in Math, but is able to put key ideas across to the lay person in a simple and understandable way. The book is called “The pleasure of finding things out”. Feynman’s lecture suggests that people who are truly passionate about what they are doing and enjoy the process of doing things, would be good at what they do...Yet so few of us know what we are truly passionate about…
Feynman in his insightful essay “The role of scientific culture in modern society” discussed the relevance of Science today. He left the discussion of positive/negative impact of science/technology to others, but focused on the following two points;
(1) The matter of judging evidence.
Often, we have a preconceived notion of what the ‘answer’ is when we collect evidences to support or refute a hypothesis/theory.
“…before you begin you must not know the answer. So you begin by being uncertain as to what the answer is. This is very, very important.”
Quantitative methods works best for sciences such as physics, mechanics and later biology, geology, anthropology and so on. But Feynman thought that it is difficult applying the same method to economics, and it failed terribly on social sciences – due to a mixture of anecdotes, uncontrolled experiments and experimenter’s biases.
(2) The freedom to doubt
Feynman believed that the most serious question a scientist should ask is about uncertainty and doubt, for “a scientist is never certain”. Instead of asking, “Is this true?”, one should ask “How likely is it true?”. People are terrified with uncertainty. But Feynman asked us to embrace it. Most actions are based on incomplete knowledge anyway, and uncertainty should be accepted as a fact of life. And people who embraces it, will constantly discover and re-discover new stuff.
Do not strive for absolute truth. Because once we decide that we have ‘achieved’ absolute truth, there will be no progress. We must always leave opportunities to alternatives. From a grand scheme of things, human being as a race is only at its infancy. If we fail to acknowledge uncertainty, “we will be chained by to the limits of our present imagination”.
How insightful.
Feynman talked about nanotechnology when the technology wasn’t even available yet. And today we have facial wash that claims that nano tech can help cleanse your pores (dunno true or not).
He asked if it is possible to teach Einstein’s theory of relativity to someone who does not understand Newtonian physics, and his answer is no. Thus most people will never be able to marvel at the wonders of the world from the eyes of Science. In some sense, the general population is no better than the ancient caveman, only with fancier tools to destroy each other.
I have given up reading on quantum physics and other Feynman materials that are more technical. My foundation is too weak to comprehend the bulk of what I’m reading. And I don’t have the interest to sustain me to plough through the basic materials…I am saddened.
Feynman in his insightful essay “The role of scientific culture in modern society” discussed the relevance of Science today. He left the discussion of positive/negative impact of science/technology to others, but focused on the following two points;
(1) The matter of judging evidence.
Often, we have a preconceived notion of what the ‘answer’ is when we collect evidences to support or refute a hypothesis/theory.
“…before you begin you must not know the answer. So you begin by being uncertain as to what the answer is. This is very, very important.”
Quantitative methods works best for sciences such as physics, mechanics and later biology, geology, anthropology and so on. But Feynman thought that it is difficult applying the same method to economics, and it failed terribly on social sciences – due to a mixture of anecdotes, uncontrolled experiments and experimenter’s biases.
(2) The freedom to doubt
Feynman believed that the most serious question a scientist should ask is about uncertainty and doubt, for “a scientist is never certain”. Instead of asking, “Is this true?”, one should ask “How likely is it true?”. People are terrified with uncertainty. But Feynman asked us to embrace it. Most actions are based on incomplete knowledge anyway, and uncertainty should be accepted as a fact of life. And people who embraces it, will constantly discover and re-discover new stuff.
Do not strive for absolute truth. Because once we decide that we have ‘achieved’ absolute truth, there will be no progress. We must always leave opportunities to alternatives. From a grand scheme of things, human being as a race is only at its infancy. If we fail to acknowledge uncertainty, “we will be chained by to the limits of our present imagination”.
How insightful.
Feynman talked about nanotechnology when the technology wasn’t even available yet. And today we have facial wash that claims that nano tech can help cleanse your pores (dunno true or not).
He asked if it is possible to teach Einstein’s theory of relativity to someone who does not understand Newtonian physics, and his answer is no. Thus most people will never be able to marvel at the wonders of the world from the eyes of Science. In some sense, the general population is no better than the ancient caveman, only with fancier tools to destroy each other.
I have given up reading on quantum physics and other Feynman materials that are more technical. My foundation is too weak to comprehend the bulk of what I’m reading. And I don’t have the interest to sustain me to plough through the basic materials…I am saddened.
Thursday, June 12, 2008
Security Analysis
"Many shall be restored that now are fallen and many
Shall fall that now are in honor."
~Horace - Ars Poetica
Picked up Security Analysis ~ 1940 (2nd edition) from our school library today. Hope i'll have the discipline to complete this book by the end of this holiday.
The quote above appears on the first page of Security Analysis, and forms part of the foundation for the idea of value investing. Today i met Jerry in the MRT station, and he asked me what exactly is "value investing"? and my immediate answer is 'cheapo investing', buy things that are 50 cents on the dollar.
But why would investable assets be sold at half price?
Most of the time it would be because of fear, and at other times because of complexity, or difference in perception.
1. Being human, we are largely driven by emotions. Although economic theory suggests that we are all rational agents, but when it comes to little pieces of paper with market prices written on it, we cease to be rational.
Keynes define rational investment as the activity in estimating the yield of the asset. However, most investors (or should we call them speculators???) prefers not spend effort in 'estimating yield', but are more interested in selling the security he has purchased at a higher price. With such aim in mind, as a security gets bidded higher and higher, frenzy takes over and the security and its underlying value gets disconnected.
As panic selling occurs, then the converse is true. It is at the point of panic selling will there be large number of mispriced securities an great opportunity to pile on great stuff on the cheap.
see the chart of Amazon.com from 1997 to 2001. It's share went $1 to $105 back down to $8, while the underlying company continue to grow its retail platform and sales volume. Investors who have the forsights and the guts to pile on to this unloved former darling are greatly rewarded.
So buy when there's fear in the air and sell when there's frenzied buying. haha. easier said than done.
(2) Complex /special situations, creates another possible avenue for mispriced security. Examples such as spinoffs, mergers, restructuring, complex capital structures historically have provided dilligent investors rich rewards.
One such example could be Tyco. It has recently split itself up into 3 company after almost a decade of wheels and deals. But the future of Tyco International is murky at best. So while the company is generating loads of free cash flow, the market is ignoring this and is focusing whether Tyco Intl can find it sense of direction in the long run.
Another example that I'm interested in but not able to decipher is Liberty Media Corporation and the sprawling empire John Malone controls. From 1 company in the early 90s, it spun off Discovery Channels (hugely profitable), swapped Liberty's stake in Rupert Murdoch's News Corp in exchage of a 41% stake in DirectTV (owned by News corp). And at the same time split the company into 3 with 2 classes of shares each. Some value investors are piling on to some parts of the company. But since I do not have sufficient understanding of what has happened, all i could do is stand a watch. However, this is also a potentially price - value disparity.
(3) Difference in perception. One man's meat is another man's poison. Value investing could very well work due to 'difference in taste'. In general, people are excited about great stories, (e.g. the next breakthrough drug) but if we can find a solid good old boring company, there's a chance that it can be a value buy. F&N in the early part of this decade is a company percieved as a boring beverage company. But in the last 3 years, people start to see it as hot property stock stock, and bidded up the stock accordingly. Only time will tell if this optimism is warranted.
Another possibility is Xin Hong's idea about generating superior return by focusing on a way longer time horizon than the rest of the investing population. This i believe hold a great chance in beating the general stock market return. Cuz in the long run, the stock market is more of a weighing machine rather than a voting machine. My only contention is that if we are in for the very long run, we better get the economics of the firm and industry right, aka competitive advantages.
Even great civilisation gets destroyed by its own undoing, other civilisations or natural disaster. Just hope that those enterprise that we back our capital with will stand the test of time.
Shall fall that now are in honor."
~Horace - Ars Poetica
Picked up Security Analysis ~ 1940 (2nd edition) from our school library today. Hope i'll have the discipline to complete this book by the end of this holiday.
The quote above appears on the first page of Security Analysis, and forms part of the foundation for the idea of value investing. Today i met Jerry in the MRT station, and he asked me what exactly is "value investing"? and my immediate answer is 'cheapo investing', buy things that are 50 cents on the dollar.
But why would investable assets be sold at half price?
Most of the time it would be because of fear, and at other times because of complexity, or difference in perception.
1. Being human, we are largely driven by emotions. Although economic theory suggests that we are all rational agents, but when it comes to little pieces of paper with market prices written on it, we cease to be rational.
Keynes define rational investment as the activity in estimating the yield of the asset. However, most investors (or should we call them speculators???) prefers not spend effort in 'estimating yield', but are more interested in selling the security he has purchased at a higher price. With such aim in mind, as a security gets bidded higher and higher, frenzy takes over and the security and its underlying value gets disconnected.
As panic selling occurs, then the converse is true. It is at the point of panic selling will there be large number of mispriced securities an great opportunity to pile on great stuff on the cheap.
see the chart of Amazon.com from 1997 to 2001. It's share went $1 to $105 back down to $8, while the underlying company continue to grow its retail platform and sales volume. Investors who have the forsights and the guts to pile on to this unloved former darling are greatly rewarded.
So buy when there's fear in the air and sell when there's frenzied buying. haha. easier said than done.
(2) Complex /special situations, creates another possible avenue for mispriced security. Examples such as spinoffs, mergers, restructuring, complex capital structures historically have provided dilligent investors rich rewards.
One such example could be Tyco. It has recently split itself up into 3 company after almost a decade of wheels and deals. But the future of Tyco International is murky at best. So while the company is generating loads of free cash flow, the market is ignoring this and is focusing whether Tyco Intl can find it sense of direction in the long run.
Another example that I'm interested in but not able to decipher is Liberty Media Corporation and the sprawling empire John Malone controls. From 1 company in the early 90s, it spun off Discovery Channels (hugely profitable), swapped Liberty's stake in Rupert Murdoch's News Corp in exchage of a 41% stake in DirectTV (owned by News corp). And at the same time split the company into 3 with 2 classes of shares each. Some value investors are piling on to some parts of the company. But since I do not have sufficient understanding of what has happened, all i could do is stand a watch. However, this is also a potentially price - value disparity.
(3) Difference in perception. One man's meat is another man's poison. Value investing could very well work due to 'difference in taste'. In general, people are excited about great stories, (e.g. the next breakthrough drug) but if we can find a solid good old boring company, there's a chance that it can be a value buy. F&N in the early part of this decade is a company percieved as a boring beverage company. But in the last 3 years, people start to see it as hot property stock stock, and bidded up the stock accordingly. Only time will tell if this optimism is warranted.
Another possibility is Xin Hong's idea about generating superior return by focusing on a way longer time horizon than the rest of the investing population. This i believe hold a great chance in beating the general stock market return. Cuz in the long run, the stock market is more of a weighing machine rather than a voting machine. My only contention is that if we are in for the very long run, we better get the economics of the firm and industry right, aka competitive advantages.
Even great civilisation gets destroyed by its own undoing, other civilisations or natural disaster. Just hope that those enterprise that we back our capital with will stand the test of time.
Wednesday, June 11, 2008
Prepare for Awesomeness
I really enjoyed KungFu Panda yesterday! Thank you Chong Long for suggesting this show! And all the incessant emails from ZB and JB that prompt me to watch this show. I laughed so hard that my voice is a little hoarse today, but TOTALLY WORTH IT. It is also very disturbing that Chong Long finds Tigress ‘hawt’, though Angelina Jolie did bring certain special appeal to the part.
Some may find the show is a little cliché. But I would also add that it is at once entertaining and inspiring. Many of us dreamt of accomplishing wonderful things when we were young, then grew up to become too practical or cynical, so sad…
Po the Panda dreamt of big things. He saw himself as the Dragon Warrior, even if he’s not endowed with the body of warrior to say the least. Well he can’t even see his toes…or other stuff…
He dreamt big and finally fulfilled his destiny as the Dragon Warrior, saving the village and his Shifu when he unleashed his latent potential. Oh yes, his chubby tummy came into great use too.
If we let our mind be plagued with thoughts of mediocrity, nothing great would ever turn out in our life. If we think a little bigger, maybe, just maybe, we can accomplish something great.
So let us free our thoughts “prepare for awesomeness”!!!
Some may find the show is a little cliché. But I would also add that it is at once entertaining and inspiring. Many of us dreamt of accomplishing wonderful things when we were young, then grew up to become too practical or cynical, so sad…
Po the Panda dreamt of big things. He saw himself as the Dragon Warrior, even if he’s not endowed with the body of warrior to say the least. Well he can’t even see his toes…or other stuff…
He dreamt big and finally fulfilled his destiny as the Dragon Warrior, saving the village and his Shifu when he unleashed his latent potential. Oh yes, his chubby tummy came into great use too.
If we let our mind be plagued with thoughts of mediocrity, nothing great would ever turn out in our life. If we think a little bigger, maybe, just maybe, we can accomplish something great.
So let us free our thoughts “prepare for awesomeness”!!!
Quotable quotes
Tai Lung (the bad guy in the show): You… You... you're just a big... fat... panda!
Po: I'm not a big fat panda. I'm *the* big fat panda.
The reasonable man adapts himself to the world; the unreasonable one persists in trying to adapt the world to himself. Therefore all progress depends on the unreasonable man.
George Bernard Shaw
Tuesday, June 10, 2008
Process vs. Outcome
Does good outcome always follow good process? Should we be focused on outcome or process, ie outcome/result driven or process driven?
To me i believe that we should always focus on the process and let the outcome take care of itself...that is if the process is truly good. Gained some new insights on process, outcome and probabilities from the Bob Rubin video interview as recommended by Xin Hong (visit xinhong's blog for a summary of the interview & link to the video).
Rubin's ideas is succintly presented by Michael Mauboussin in this book "More than you know".
In essence,
1. The only certainty is that there is no certainty
2. Decisions are a matter of weighing probabilities
3. Despite uncertainty, we must act
4. Judge decisions not only on results, but also on how they were made
On point four, the author also pointed us to the research of Jay Russo and Paul Schoemaker, who classified process and outcome in a simple 2 by 2 matrix,
1. Good Process + Good Outcome = Deserved Success
2. Good Process + Bad Outcome = Bad Break
3. Bad Process + Good Outcome = Dumb Luck
4. Bad Process + Bad Outcome = Poetic Justice
I LOVE this classification, for it allows me to evaluate my decision (usually after the outcome has occured) and see which category this event falls into.
For instance, I have no idea how to do well in one of my modules (CAT), but due to pple around me that did the whole project for me (Daniel, Damien, Aeron with inputs from Andrew), i got a good grade, so its considered a pure "DUMB LUCK" case.
However, it is also possible to decieve ourselves that we are just plain unlucky if Bad Outcome keeps occuring because the bad outcome could very well stem from our bad process.
Phillip Fisher said that its ok that a company makes loss in a few quater if they are building the company for the long term (e.g. High marketing expense to penetrate market), but if after a few years, the company is still bleeding, there's something wrong with the company. NO long term profits are made from series of short term loss.
End this with a quote from Bob Rubin, "It’s not that results don’t matter. They do. But judging solely on results is a serious deterrent to taking risks that may be necessary to making the right decision. Simply put, the way decisions are evaluated affects the way decisions are made."
----------------------------------------------------------
Btw, Daniel just watched Avenue Q in London, and sent me this message at 4 in the morning, "Avenue Q is a fucking riot!". Haha, probably means that he's blown away by the show.
Can't wait to watch it in November when it comes to Singapore. Hope its not some watered down version.
To me i believe that we should always focus on the process and let the outcome take care of itself...that is if the process is truly good. Gained some new insights on process, outcome and probabilities from the Bob Rubin video interview as recommended by Xin Hong (visit xinhong's blog for a summary of the interview & link to the video).
Rubin's ideas is succintly presented by Michael Mauboussin in this book "More than you know".
In essence,
1. The only certainty is that there is no certainty
2. Decisions are a matter of weighing probabilities
3. Despite uncertainty, we must act
4. Judge decisions not only on results, but also on how they were made
On point four, the author also pointed us to the research of Jay Russo and Paul Schoemaker, who classified process and outcome in a simple 2 by 2 matrix,
1. Good Process + Good Outcome = Deserved Success
2. Good Process + Bad Outcome = Bad Break
3. Bad Process + Good Outcome = Dumb Luck
4. Bad Process + Bad Outcome = Poetic Justice
I LOVE this classification, for it allows me to evaluate my decision (usually after the outcome has occured) and see which category this event falls into.
For instance, I have no idea how to do well in one of my modules (CAT), but due to pple around me that did the whole project for me (Daniel, Damien, Aeron with inputs from Andrew), i got a good grade, so its considered a pure "DUMB LUCK" case.
However, it is also possible to decieve ourselves that we are just plain unlucky if Bad Outcome keeps occuring because the bad outcome could very well stem from our bad process.
Phillip Fisher said that its ok that a company makes loss in a few quater if they are building the company for the long term (e.g. High marketing expense to penetrate market), but if after a few years, the company is still bleeding, there's something wrong with the company. NO long term profits are made from series of short term loss.
End this with a quote from Bob Rubin, "It’s not that results don’t matter. They do. But judging solely on results is a serious deterrent to taking risks that may be necessary to making the right decision. Simply put, the way decisions are evaluated affects the way decisions are made."
----------------------------------------------------------
Btw, Daniel just watched Avenue Q in London, and sent me this message at 4 in the morning, "Avenue Q is a fucking riot!". Haha, probably means that he's blown away by the show.
Can't wait to watch it in November when it comes to Singapore. Hope its not some watered down version.
Sunday, June 8, 2008
For Good
I'm listening to the recording of Wicked again. Thank you Guowei for passing me the score to the song "For Good", and hope u could defy gravity some day too. The song makes me think of all the great pple in my life that makes me a better person, and accepting me despite all my short comings.
Lyrics
GLINDA:
I've heard it said
that people come into our lives
for a reason
bringing something we must learn
and we are led to those
who help us most to grow
if we let them and we help them in return
Well I don't know if I believe that's true
but I know I'm who I am today because I knew you...
like a comet pulled from orbit as it passes the sun,
like a stream that meets a boulder halfway through the wood
who can say if I've been changed for the better?
But because I knew you I have been changed for good
ELPHABA:
It well may be that
we will never meet again
in this lifetime
so let me say before we part:
so much of me is made of what I learned from you
you'll be with me, like a handprint on my heart
now whatever way our stories may end
I know you have rewritten mine by being my friend
Like a ship blown from it's mooring by a wind off the sea
like a seed dropped by a sky bird in a distant wood
who can say if I've been changed for the better?
But because I knew you... I have been changed for good
GLINDA
Because I knew you...
BOTH
I have been changed for good
ELPHABA
And just to clear the air I ask forgiveness for what you blame me for...
GLINDA
Well I guess there is blame to share...
BOTH
And none of it seems to matter anymore
GLINDA (same time as Elphaba)
Like a comet pulled from orbit as it passes the sun, like a stream that meets a boulder halfway through the wood
ELPHABA (same time as Glinda)
Like a ship blown off it's mooring by a wind off the sea, like a seed dropped by a skybird in the wood
BOTH
Who's to say if I've been changed for the better?
GLINDA
because I knew you,
ELPHABA
because I knew you
BOTH
I have been changed for good
For Good (original song)
For Good (rehearsal)
--------------------------------------------------
Xin Hong, I'm so glad that you'll be meeting up with Third Avenue next week. All the best. I really admire you for all that you've done to be a better investor. I'll gladly buy 10% of you.
Jie Chao, i salute you for your courage in facing your Strategy paper this Wed with less than a week of preperation when you realise its the best option right now. Jia You!!!
--------------------------------------
I'm blown away when reading Jie Chao's book on Mr Bon Bon with regards to the philosopher's notion of Knowledge, Understanding and Being. I may never really comprehend it enought to write about it. But have you ever wonder why when you read something exactly the same over the span of a few years, and yet why you feel diffent, or didn't see things that way in the past? In essence its a discussion on such issues. To me its a little to 'chim'. Haha.
Thank you all for being around me.
Lyrics
GLINDA:
I've heard it said
that people come into our lives
for a reason
bringing something we must learn
and we are led to those
who help us most to grow
if we let them and we help them in return
Well I don't know if I believe that's true
but I know I'm who I am today because I knew you...
like a comet pulled from orbit as it passes the sun,
like a stream that meets a boulder halfway through the wood
who can say if I've been changed for the better?
But because I knew you I have been changed for good
ELPHABA:
It well may be that
we will never meet again
in this lifetime
so let me say before we part:
so much of me is made of what I learned from you
you'll be with me, like a handprint on my heart
now whatever way our stories may end
I know you have rewritten mine by being my friend
Like a ship blown from it's mooring by a wind off the sea
like a seed dropped by a sky bird in a distant wood
who can say if I've been changed for the better?
But because I knew you... I have been changed for good
GLINDA
Because I knew you...
BOTH
I have been changed for good
ELPHABA
And just to clear the air I ask forgiveness for what you blame me for...
GLINDA
Well I guess there is blame to share...
BOTH
And none of it seems to matter anymore
GLINDA (same time as Elphaba)
Like a comet pulled from orbit as it passes the sun, like a stream that meets a boulder halfway through the wood
ELPHABA (same time as Glinda)
Like a ship blown off it's mooring by a wind off the sea, like a seed dropped by a skybird in the wood
BOTH
Who's to say if I've been changed for the better?
GLINDA
because I knew you,
ELPHABA
because I knew you
BOTH
I have been changed for good
For Good (original song)
For Good (rehearsal)
--------------------------------------------------
Xin Hong, I'm so glad that you'll be meeting up with Third Avenue next week. All the best. I really admire you for all that you've done to be a better investor. I'll gladly buy 10% of you.
Jie Chao, i salute you for your courage in facing your Strategy paper this Wed with less than a week of preperation when you realise its the best option right now. Jia You!!!
--------------------------------------
I'm blown away when reading Jie Chao's book on Mr Bon Bon with regards to the philosopher's notion of Knowledge, Understanding and Being. I may never really comprehend it enought to write about it. But have you ever wonder why when you read something exactly the same over the span of a few years, and yet why you feel diffent, or didn't see things that way in the past? In essence its a discussion on such issues. To me its a little to 'chim'. Haha.
Thank you all for being around me.
Thursday, June 5, 2008
The Bell Curve
Most of us in uni have to live the Bell curve. And we often hear that 'your results are bell-ed' so all you have to do is to perform better than the majority. So even if you fail, just make sure your failing mark is higher than average.
The bell curve, or the normal distribution, explains an amazing numbers of phenomenon. Height, or instance forms a rather nice bell curve, so does mortality rate and some say intelligence. However, it fails remarkably when it is used as a measurment for systems that respond to feedback and extreme sensitivity to initial condition.
Population of cities rarely follows a normal distribution. Imagine a small area where pple gather to trade. Once that area reaches a critical mass of population, infrastructures will be built around this area. City dwellers will try to stay as near to these area as possible. Thus having a high concentration of population/square foot. A related example would be the number of offices in Raffles Place vs Choa Chu Kang. Assume you plot a graph of offices per square foot for all the districts in Singapore, you wouldn't get a bell curve, but a very 'lumpy' curve.
In finance, there's also a huge obession over the 'average'. Be it average return, average risk, etc. Average return are sometimes called "Expected Return". However be wary of such terms, the "expected" is rarely to be expected. How many times have you heard where people sell you financial products that promises this 'expected return' but fail to highlight the fact that results over the years would be bumpy? It is like saying its safe to put one hand in a tub of boiling water and the other in ice water as the 'average temperature' is room temperature.
My amazing CAT (computer as an analysis tool) prof, Michelle Cheong, told us that most Uni teaches only normal distribution because its the easiest to teach, and the math behind is also one of the most elegant one. An important quality of the normal distribution is, The odds of a deviation decline exponentially as you move away from the average.
E.g. from The Black Swan, assume that average height is 1.67m and we consider the odds of someone being x cm taller than average.
10 cm taller than average, odds: 1 in 6.3
20 cm taller than average, odds: 1 in 44
30 cm taller than average, odds: 1 in 740
40 cm taller than average, odds: 1 in 32,000
50 cm taller than average, odds: 1 in 3,500,000
60 cm taller than average, odds: 1 in 1,000,000,000
70 cm taller than average, odds: 1 in 780,000,000,000
80 cm taller than average, odds: 1 in 1,600,000,000,000,000
90 cm taller than average, odds: 1 in 8,900,000,000,000,000,000
100 cm taller than average, odds: 1 in 1.3 x 10^23 (i gave up typing the zeros)
It may be true through emprical testing that the odds of meeting someone who is alive and have a height of 2.67m is that rare ( 1 in 1.3x10^23). However, economist (or later finance professors) applied the bell curve to financial market. This is one of the contributing factor to the famous LTCM debacle which caused the financial market to seize up in the late nineties. The super successful hedge fund was destroyed as they over bet on a series events that should only happen in 1 in a few billion years as predicted by their model. But it all happend within the short span of a few weeks starting with the default of Russian bond.
I think as human beings we love certainty, and cannot see risk that has not happened before. However, it would be just wrong to simply use fancy models or theories to predict the future when the underlying assumptions are flawed. As Lord Keynes said, "It is better to be roughly right than precisely wrong. "
DO YOU KNOW? John Maynard Keynes was also a great investor. His Chest Fund returned a 9.1% from the period of 1927 to 1945, surviving both the great depression and World War II, and far surpassing the -0.9% return of the general British stock market. Read more about him here. Hiaz, why my JC econs textbook never did mention this?
The bell curve, or the normal distribution, explains an amazing numbers of phenomenon. Height, or instance forms a rather nice bell curve, so does mortality rate and some say intelligence. However, it fails remarkably when it is used as a measurment for systems that respond to feedback and extreme sensitivity to initial condition.
Population of cities rarely follows a normal distribution. Imagine a small area where pple gather to trade. Once that area reaches a critical mass of population, infrastructures will be built around this area. City dwellers will try to stay as near to these area as possible. Thus having a high concentration of population/square foot. A related example would be the number of offices in Raffles Place vs Choa Chu Kang. Assume you plot a graph of offices per square foot for all the districts in Singapore, you wouldn't get a bell curve, but a very 'lumpy' curve.
In finance, there's also a huge obession over the 'average'. Be it average return, average risk, etc. Average return are sometimes called "Expected Return". However be wary of such terms, the "expected" is rarely to be expected. How many times have you heard where people sell you financial products that promises this 'expected return' but fail to highlight the fact that results over the years would be bumpy? It is like saying its safe to put one hand in a tub of boiling water and the other in ice water as the 'average temperature' is room temperature.
My amazing CAT (computer as an analysis tool) prof, Michelle Cheong, told us that most Uni teaches only normal distribution because its the easiest to teach, and the math behind is also one of the most elegant one. An important quality of the normal distribution is, The odds of a deviation decline exponentially as you move away from the average.
E.g. from The Black Swan, assume that average height is 1.67m and we consider the odds of someone being x cm taller than average.
10 cm taller than average, odds: 1 in 6.3
20 cm taller than average, odds: 1 in 44
30 cm taller than average, odds: 1 in 740
40 cm taller than average, odds: 1 in 32,000
50 cm taller than average, odds: 1 in 3,500,000
60 cm taller than average, odds: 1 in 1,000,000,000
70 cm taller than average, odds: 1 in 780,000,000,000
80 cm taller than average, odds: 1 in 1,600,000,000,000,000
90 cm taller than average, odds: 1 in 8,900,000,000,000,000,000
100 cm taller than average, odds: 1 in 1.3 x 10^23 (i gave up typing the zeros)
It may be true through emprical testing that the odds of meeting someone who is alive and have a height of 2.67m is that rare ( 1 in 1.3x10^23). However, economist (or later finance professors) applied the bell curve to financial market. This is one of the contributing factor to the famous LTCM debacle which caused the financial market to seize up in the late nineties. The super successful hedge fund was destroyed as they over bet on a series events that should only happen in 1 in a few billion years as predicted by their model. But it all happend within the short span of a few weeks starting with the default of Russian bond.
I think as human beings we love certainty, and cannot see risk that has not happened before. However, it would be just wrong to simply use fancy models or theories to predict the future when the underlying assumptions are flawed. As Lord Keynes said, "It is better to be roughly right than precisely wrong. "
DO YOU KNOW? John Maynard Keynes was also a great investor. His Chest Fund returned a 9.1% from the period of 1927 to 1945, surviving both the great depression and World War II, and far surpassing the -0.9% return of the general British stock market. Read more about him here. Hiaz, why my JC econs textbook never did mention this?
Tuesday, June 3, 2008
Investing in insurance firm, great bargain or value trap?
Warning: Extremely long and boring post. Seeks to explain how insurance firm makes money and explore if we can profit from owning such firms.
I’m interested in how insurance firm in general makes money. I’d like to put down what I think I know in words such that I’m able to review my train of thoughts later on.
So how do insurance companies make their profit?
Traditional insurance companies essentially have 2 sources of income;
1. Underwriting profit / loss
2. Investment profit / loss
Underwriting profit is generated if the company manage to sell insurance product that pays out LESS than what it gets. Imagine, people pay their premium to get insured, of all the people that bought the insurance, only a small percentage would eventually claim for it.
Example
- 1,000 motorcyclists buy insurance, paying a total amount of premium of $1,000,000.
- 5% of motorcyclists eventually claim for injury/death/vehicle damages, etc, which amount to -- $600,000 in total (average of 12k per claim).
- Administrative expense for the firm is 150k
> Underwriting profit is thus 250 k, (1mil- 600k – 150k)
In insurance terms, this company has a “combined ratio” of 75%, which means that for every $100 premium, it roughly generates $25 underwriting profit.
Now, we know that there’s a time lag between the time where premiums is received and final claim is made. So the insurance firm can invest the money and make return on this money that is technically ‘not his’.
Example (continued from above)
- Premium of $1,000,000 is received on 1st Jan
- Claims will only be paid on 31st Dec.
- Company buys a 1 year risk free govt bond which gives a return of 5%, ie $50k.
-Therefore investment profit is $50k
> Total profit for the year would be 250k + 50k, presto! Money materialise out of thin air with little capital injected.
Here comes the tough part, few insurance firm generate high underwriting profit. In a bid to win market share, most companies will sacrifice profitability for growth. Furthermore, there are also some risks that are not known for many years. Warren Buffett commented that Berkshire Hathaway under charged for its terrorism related insurance contract pre-911. Few people perceived the risk of terrorism to be so high before that day.
Furthermore, if previously uncorrelated risk occurs together, the insurance firm may not have the capital to pay up when insured parties file claims. Imagine from our example, 10% (instead of 5%) of motorcyclist got into accident in that year. Then the total claim would be $1.2 million. Wiping out the premium earned for that year and investment return.
With all these risks in mind, there are some stellar insurance firms around. Of course there’s Buffett’s Berkshire Hathaway, US car insurer Progressive Corp, and P&C insurer Markel Corp. All three generates healthy combined ratio, and Berkshire and Markel in particular generate super healthy return on its investment portfolio.
I love Progressive because it is one of the most rational auto-policy underwriter in the US. It adopts a very low cost model, and is a super lean corporation. It wrote less insurance contract last year and returned money to shareholder as the competitors undercut each other to gain market share. It takes guts to NOT do silly things when everyone else goes crazy. When prices get better, Progressive will be once again be well capitalised and prepared to capture profitable growth.
Value Traps???
In the market turmoil over the last year, a few companies have fallen hard. Two of the insurers that is interesting are AIG and MBIA. AIG has fallen on hard times as its investment in many assets that are related to derivatives instruments and sub prime suffer huge write down. However it is still generating huge underwriting profits with a healthy combined ratio of 96.8. It is one of the largest insurer in US and Asia. There are few insurer in Asia with the depth and breath of knowledge that can match AIG. It is selling at a very low P/B of 1.12. Lowest in nearly a decade. Is it a great value stock? Or are there hidden dangers that we know not.
MBIA is a more extreme example. It has ‘lost’ billions of dollars on insurance contract that insures CDOs and other RMBS (residential mortgage backed securities). Much of the suffering it is going through now is purely its own doing.
Historically its combined ratio is around 60% to 75%, obscenely profitable. Being overconfident with its financial models, they began to underwrite insurance on assets which are new and shiny - different type of securitised contracts. They got caught with their pants down over the past year as different securities defaults and or missed their interest payment. Buffett once said that, “Only when the tide goes out do you discover who's been swimming naked”. However this time round you get to see not only MBIA swimming naked, but also frolicking with the likes of rating agencies, banks and even government agencies.
Oh ya, why am I interested in this very badly behaved creature? Cuz its so cheap. Its selling at a P/B of 0.2. Assuming that (i) it survives this storm for the next 3 years without raising additional capital, (ii)even if it does not make a single cent, (iii) not lose too much money, and (iv) the market realize that it’s not going to go bust, then it should sell around a P/B of at least 1.
Worse case: company goes bust, and there goes my investment. Normal case, company survives and capital market returns to normal within 3 years, and stocks sells at book. Assume a 50/50 chance, then E(X) = (500%)(0.5) + (0)(0.5) = 250% of return for the 0.2 cents I put in. 35% annulized. Not bad. However, with my current knowledge, it is as good as gambling (with I think slightly better odds than Toto or 4D). If I figure this out, I may just put some money in for this experiment. AND I fully admit that this is SPECULATION, not Investing as safety of principle cannot be ascertained.
Furthermore, I don’t fully understand the impact of fair value accounting on the books of AIG and MBIA due to my limited accounting knowledge. Some of the losses booked by both companies has not incurred, and is unlikely to occur. But I dun understand the gibberish in their 10k and 10Q notes to accounts!
Ahhh!!! Gotta expand my tools on hand fast.
Disclosure: I own stocks of Markel and Progressive.
Added some links at the side that i think is rather useful. Do tag/email me if you've got any suggestions to other great sites!
Sunday, June 1, 2008
The Age of Not Believing
I was cleaning up my room yesterday and saw this old 'Classic Disney' CD i have. It's been more than a few years since i've played it. After singing along to familiar songs like Be Our Guest, and Supercalifragilisticexpialidocious, a new (very old) song caught my attention, its called The Age of Not Believing sung by the very lovely Angela Lansbury (Mrs Potts in beauty and the beast).
I felt weirdly sad and happy after hearing the song. A lost of innocence, a coming of age.
The Age of Not Believing
When you rush around in hopeless circles,
searching everywhere for something true,
you’re at the age of not believing,
when all the make-believe is through.
When you’ve set aside your childhood heroes
and your dreams are lost upon a shelf,
you’re at the age of not believing
and, worst of all, you doubt yourself.
You’re a castaway where no one hears you
on a barren isle in a lonely sea.
Where did all the happy endings go?
Where can all the good times be?
You must face the age of not believing,
doubting everything you ever knew,
until at last you start believing
there’s something wonderful in you.
You’re at the age of not believing
and, worst of all, you doubt yourself.
You’re a castaway where no one hears you
on a barren isle in a lonely sea.
Where did all the happy endings go?
Where can all the good times be?
You must face the age of not believing,
doubting everything you ever knew,
until at last you start believing
there’s something wonderful in you .
I felt weirdly sad and happy after hearing the song. A lost of innocence, a coming of age.
The Age of Not Believing
When you rush around in hopeless circles,
searching everywhere for something true,
you’re at the age of not believing,
when all the make-believe is through.
When you’ve set aside your childhood heroes
and your dreams are lost upon a shelf,
you’re at the age of not believing
and, worst of all, you doubt yourself.
You’re a castaway where no one hears you
on a barren isle in a lonely sea.
Where did all the happy endings go?
Where can all the good times be?
You must face the age of not believing,
doubting everything you ever knew,
until at last you start believing
there’s something wonderful in you.
You’re at the age of not believing
and, worst of all, you doubt yourself.
You’re a castaway where no one hears you
on a barren isle in a lonely sea.
Where did all the happy endings go?
Where can all the good times be?
You must face the age of not believing,
doubting everything you ever knew,
until at last you start believing
there’s something wonderful in you .
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