Monday, November 1, 2010

Fruitful decade for Singaporeans

The Business Times

By Roy Varghese

Foundation Adviser
IPAC Singapore

WITH less than 100 days to the end of 2010, it makes sense to take stock of the first decade of the new millennium. Baby boomers, those born between 1946 and 1964, have a special incentive to reflect on the past and take charge of the future to ensure that their quality of lifestyle in retirement is not permanently impaired as a result of the massive negative impact of global bear markets in the last 10 years.

The experience of investors and families in this decade will vary based on their circumstances and where they live and work. American baby boomers, especially those who are about to start their retirement, generally feel that they have made no progress in this miserable decade as the US stock market is now at the same level or below what it was on Jan 1, 2001.

Singapore's middle-class families, in contrast, have a lot to be grateful for in the same period. In 2001, the youngest cohort of baby boomers was probably starting families and living in their first homes. Now, in their mid-40s, most of them may be close to being mortgage-free unless they upgraded to private property.

Meanwhile, Singapore baby boomers in their mid-50s are dealing with funding children's tertiary education and building their retirement capital, which took a substantial hit two years ago if the portfolios were invested in higher-risk assets.

Finally, those in the early to mid-60s may be anxious about having enough resources to see them through retirement in the next two decades.

To understand the gripes of investors who are still under water as a result of the 2008 global financial crisis, I ran a series of simulations comparing lump-sum investing and regular savings plans in MSCI World Index, S&P 500 Index, Berkshire Hathaway-A (BRK-A) and the Straits Times Index (STI), all measured in US dollars.

There are some interesting conclusions for the serious-minded wealth accumulator.
MSCI World Index

If you invested US$100,000 into the MSCI World Index 10 years ago (through an exchange-traded fund or index fund if it existed in 2001), your portfolio would be worth US$80,000 today.

If you invested US$10,000 every year starting September 2000, your portfolio would be worth US$106,000 today.

In reality, it's unlikely anyone in the world would have chosen either of these two approaches exclusively.

The principle here is the application of basic diversification in global equities based on stocks from selected developed countries.

The exclusion of developing markets from this index is reason enough to question if the MSCI World Index is a relevant benchmark for retail investors in the new world order.

S&P 500

If you invested US$100,000 into the S&P 500 Index 10 years ago, the portfolio would be valued at US$78,000 today. This is slightly worse than the MSCI World Index lump-sum strategy.

On the other hand, if you had invested US$10,000 every year for 10 years as part of a regular investment programme, your portfolio would be worth US$99,000 today.

An American retail investor seeking exposure to large-cap domestic stocks might have included this index as part of a larger portfolio. This is why there is widespread unhappiness among Americans who feel that they were let down by their domestic stock market despite diligent regular investing over a 10-year period in a pension plan.

Berkshire Hathaway

As an American or international investor who is a fan of Warren Buffett, let's assume that you invested US$100,000 into the BRK-A stock 10 years ago.

You would own one share plus change of this legendary stock that would be worth US$194,000 today, up by 94 per cent.

If it were possible to buy fractional BRK-A as part of a regular savings plan, investing US$10,000 per year over 10 years would have created a single-stock portfolio with less than two shares of BRK-A worth US$ 146,000.

Mr Buffett's stock picks have proven superior to any diversified global or American equity market in this decade.

Straits Times Index

Finally, if you invested US$100,000 into the STI 10 years ago, your portfolio would be worth about US$198,000 today.

It would have almost doubled in 10 years and this works out to be an annual growth rate of 7 per cent in US dollar terms.

As a disciplined Singapore investor who invested US$10,000 equivalent per year over 10 years into the STI, presumably with manual construction of the index (which has changed its component stocks over time), your portfolio would be worth US$191,000 today .

The low base in Singapore stock prices in September 2000 gave the lump-sum approach a slight edge over regular investing.

In any case, it cannot be denied that the dazzling recovery from the two bear markets in this decade resulted in the STI being the clear winner of the four pairs of scenarios in our simulation.

Conclusions on the outcomes

Before we draw some over-arching conclusions, it is worth clarifying two points.

First, dividends from the underlying stocks are not reflected in the indexes, which measure only price changes. This means that at least 2 per cent per annum of dividend yield can be added to the annualised returns for all four scenarios to estimate total returns more accurately.

Second, we have not considered fees and charges for fund management, financial advice or income taxes. At the individual investor level, the actual results would not have been exactly the same as the simulated performance. Overall, we can be confident the general outcomes of the four scenarios can provide us some direction going forward.

In terms of the merits of anchoring a diversified portfolio to US domestic large caps, shadowing the MSCI World Index and the S&P 500 was detrimental to investment performance after 10 years.

The global financial crisis had a more severe impact on US stocks than either Singapore equities or Berkshire Hathaway.

There were two separate bear markets that impacted US equities this decade: the 2001 to 2003 global recession (-50 per cent) and the 2008 to 2009 global financial crisis (-45 per cent).

The Singapore stock market generally mimicked the declines of the S&P 500 but the ensuing bull markets in 2003 to 2007 (+200 per cent) and 2009 to the present (+100 per cent) have propelled the STI to a brilliant position compared to the start of the decade. BRK-A was more like the STI than the S&P 500 except that the Berkshire recovery was more stellar after the first recession compared to the post Wall Street meltdown of 2008.

Mr Buffett can afford the risk-concentrated holdings in the Berkshire conglomerate that includes insurance company Geico, railway Burlington Northern Santa Fe, Washington Post, Amex, Coke, Goldman Sachs and General Electric. This may not be appropriate for retail investors who need diversity in their portfolio.

Asset allocation, with asset classes outside equities, remains the cornerstone of sound investment strategies for individuals, especially those who are very close to retirement.

On the question of dollar-cost averaging versus lump-sum investing based on the four selected candidates, it is clear that adding to the portfolio after a steep market decline pays off in the future. Mechanical equal investing may not be optimal; a shrewd investor should be prepared to do ad-hoc top-ups to the portfolio when a correction is deemed substantial. Professional advice is strongly recommended when investors are confused, irrationally exuberant or nervous.

What now for Singaporeans?

Based on anecdotal evidence, Singaporean baby boomers who own private property did very well this decade if they measured growth in personal net worth. This is a simple exercise to do. Subtract liabilities from assets on Jan 1, 2001 and compare this figure with your net assets today. Private property values may have doubled or tripled over the decade.

If this is indeed the case, a compounded growth rate of 10 per cent per annum in personal net worth is entirely possible. That's a better growth rate than the STI of bluechip stocks held over the decade.

Even iconic Berkshire Hathaway delivered only 4 per cent per annum in Sing dollar terms over the decade owing to the massive depreciation of the US dollar in the last few years.

How can an investor justify a hypothetical benchmark of 10 per cent per annum compounded growth rate for his personal net worth? Add a risk premium of 3 per cent per annum to a risk-free yield of 3 per cent per annum and inflation of 3 per cent per annum over the long term and one per cent per annum currency impact for foreign currency assets and you get a rough benchmark of 10 per cent per annum nominal growth rate for personal net worth.

What this means is that a Singapore investor should not be bound to global indexes for personal net worth progress reporting. For a moderate-risk baby boomer, a globally diversified portfolio of equities, with no more than 20 per cent dedicated to US stocks, plus bonds, Reits, Singapore and Asian equities represents an ideal investment core. (Older baby boomers should have more bonds and defensive assets).

Private property underpins the liquid assets for long-term capital appreciation of retirement capital.

Baby boomers in Singapore received an excellent tutorial from The Lost Decade that never was.

These are the writer's personal views and not ipac's.
This article was first published in The Business Times.

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