Keep INVESTING Simple and Safe (KISS)
****Investment Philosophy, Strategy and various Valuation Methods****
The same forces that bring risk into investing in the stock market also make possible the large gains many investors enjoy. It’s true that the fluctuations in the market make for losses as well as gains but if you have a proven strategy and stick with it over the long term you will be a winner!****Warren Buffett: Rule No. 1 - Never lose money. Rule No. 2 - Never forget Rule No. 1.
Bond investing can sometimes fail, despite being traditionally considered a safe and steady investment.
Interest rates, inflation, and credit ratings can all affect the value of bonds, and investors need to carefully consider these factors before investing in them.
For example, the Puerto Rican government's default on its bond payments, which resulted in losses for many investors who had bought the bonds.
Be wary of the risks associated with high-yield or "junk" bonds, which offer higher returns but also come with a higher risk of default.
Conclusion:
While bond investing can be a useful tool for investors looking for steady income, it is important to understand the risks involved and to diversify one's portfolio across different types of investments.
Malaysian banks rating intact despite US bank failures - RAM Ratings
Publish date: Sat, 18 Mar 2023, 08:06 AM
KUALA LUMPUR - RAM Rating Services Bhd (RAM Ratings) sees no rating impact on Malaysian banks from the failure of the United States Silicon Valley Bank (SVB) and two other smaller banks last week.
The rating agency said that in Malaysia, banks' credit fundamentals remained robust and resilient supported by strong regulatory supervision to weather heightened volatility in global financial markets.
"Compared to SVB, we see fundamental differences in the business and balance sheet profiles of commercial banks in Malaysia.
"Domestic commercial banks typically engage in more lending activities as opposed to relying on bond investments which are exposed to market volatility. The proportion of domestic banking system assets invested in bond securities is less than 25 per cent," it said in a statement today.
SVB, on the other hand, had more than 50 per cent of its asset base in such securities, which led to huge unrealised losses amid rapid and steep interest rate hikes in the US.
Moreover, less than 40 per cent (on average) of bond holdings in Malaysia's eight major banks are classified as held to maturity (HTM), while the rest are marked to market.
"This means that fair value losses on bond securities are already largely reflected in the banks' capital position. In contrast, SVB classified almost 80 per cent of bond securities as HTM (only a little over 20 per cent were marked to market), indicating that unrealised losses had not yet been reflected in its equity.
"HTM bonds are carried at amortised cost in the balance sheet given the intention to hold these securities to maturity, so fair valuation losses are not captured in the capital," it said.
RAM Ratings said fair value losses in Malaysian banks were also significantly smaller, thanks to Bank Negara Malaysia's (BNM) milder pace of rate hikes and banks' prudent strategy of holding shorter-tenure bonds in recent times.
The domestic banking industry's common equity tier-1 capital ratiostayed at a robust 14.9 per cent at end-2022 from 2021's 15.5 per cent.
"Further valuation losses, if any, should be less severe given the central bank's cautious stance on further rate hikes," said the rating agency, adding that banks in Malaysia are predominantly funded by customer deposits, with high granularity.
Their liquidity profiles are also sound with liquid assets to deposits ratio of around 20 per cent and a net loans to deposits ratio of 88 per cent, it added.
According to BNM, domestic banks have no direct exposure to the three failed US banks.
"The central bank's robust prudential oversight and good track record - which have been evident in previous financial crises - should ensure the continued financial stability of the Malaysian banking system," it noted.
Why bonds produced such dreadful returns after 1945
In the 1940s, interest rates had been falling for the better part of 20 years as the Great Depression drove knee-jerk risk aversion, and hit record lows as various policies and incentives moved to cheaply finance wartime deficits.
According to Yale economist Robert Shiller, 10-year Treasuries yielded
5% in 1920,
3% by 1935, and
2% by the early 1940s.
The consensus came to believe low rates were a permanent fixture. "Low Interest Rates for Long Time to Come," read one newspaper headline in 1945.
But as the saying goes, if something can't go on forever, it won't.
By 1957, 10-year Treasuries yielded 4%.
By 1967, 5%.
They breached 8% in 1970, and zoomed to
15% by 1981 as inflation scorched the economy.
Since bond prices move in the opposite direction of interest rates, this was devastating to returns. Deutsche Bank has an archive of Treasury returns in real (after inflation) terms, which tells the story:
Period
Average Annual RealReturns, 10-Year Treasuries
1940-1949
(2.5%)
1950-1959
(1.8%)
1960-1969
0.2%
1970-1979
(1.2%)
Source: Deutsche Bank Long Term Asset Return Study.
Don't underappreciate how awful this was. In real terms, $1,000 invested in 10-year Treasuries in 1940 would have been worth $584 by 1979 -- this for an investment often trumpeted as "risk-free."
Lessons
No one knows if the same performance will be repeated over the coming years.
Japan is a good example of extremely low interest rates sticking around for decades.
But the risks are obvious.
With 10-year Treasuries yielding 1.5%, there is virtually no chance of high returns over the next decade.
The odds of being hammered and suffering negative real returns are, however, quite good.
What does the bond market turmoil mean for investors?
US Treasuries have suffered the worst start since 1788 after falling by 9.8 per cent this year, triggering experts to question the 60/40 portfolio strategy
The bond market has suffered a record $10 trillion sell-off this year. AP
Investors fretting over this year’s $13 trillion global stock market crash may have overlooked similar carnage in a market that is actually more important for the global economy.
The bond market has also suffered a record $10tn sell-off and this could hit investors just as hard because a strange thing is happening.
Both shares and bonds are crashing at the same time. That is something financial experts say isn’t supposed to happen.
But in 2022, it is. Which means there is no hiding place for investors in this troubled year. There may also be an opportunity, if you are sharp.
Retail investors may pay little attention to the bond market but institutions and governments have been known to obsess over it.
For them, the bond market is the big one. It is about triple the size of the global stock market and plays an essential role in keeping economic activity ticking. At the end of last year, the bond market was worth about $120tn, against $41.8tn for global shares.
If the bond market gets bumpy, everybody is in for a rough ride.
Governments issue bonds to raise money for their spending while companies use them to generate the funds they need to grow. Both promise to pay investors a fixed rate of interest over a preset term, with a guarantee to return their original capital afterwards.
At maturity, the issuing government or company must repay the debt. If it cannot, there is trouble.
Bonds are traded by investors, which means their value can constantly change, depending on factors such as inflation, interest rates and demand. As is the case with shares, bond prices can rise and fall. Just not as much. Usually.
Ordinary investors rarely buy individual bonds but invest through a fund holding a spread of government or corporate bonds.
Bonds offer them a fixed rate of interest plus capital growth if prices rise, with fewer of the ups and downs you find with shares.
The two are supposed to be non-correlating assets. So, when shares fall, bonds are supposed to mitigate losses by standing firm.
The one thing they are not supposed to do iscrash simultaneously. Yet, that is what is happening right now.
For decades, financial planners said the safest way to generate steady, strong long-term returns is to invest 60 per cent of your money in shares and 40 per cent in bonds.
The classic 60/40 portfolio strategy has generated an impressive average return of 11.1 per cent a year over the past decade.
You can even buy exchange-traded funds (ETFs) that automatically deliver this, such as the BlackRock 60/40 Target Allocation Fund or the Vanguard 60% Stock/40% Bond Portfolio.
The writing was on the wall for the 60/40 strategy last year, as US large-cap stocks hit record-high valuations, while US Treasury government bond yields neared record lows.
“For all intents and purposes, we think investors have many reasons to be concerned that the 60/40 might be dead,” Nick Cunningham, vice president of strategic advisory solutions at Goldman Sachs Asset Management, said last October.
This will hit investors who had even never heard of the 60/40 rule because “we see shades of the classic 60/40 present in many portfolios due to an over-concentration in the most familiar asset classes", Mr Cunningham added.
As this warning proves prescient, it may be worth looking at your portfolio to see how exposed you are to this double jeopardy.
This has been a challenging year across the board, says Jason Hollands, managing director of investment platform Bestinvest.
“2022 has seen one of the worst starts to a calendar year for core US assets on record,” he says.
US Treasuries have suffered the worst start to a year since 1788, according to Deutsche Bank, falling 9.8 per cent. Bloomberg
US Treasuries have suffered the worst start since 1788, according to Deutsche Bank, falling by 9.8 per cent. That isn’t supposed to happen to the bond market.
“At the same time, the S&P 500 Index of US shares has fallen 20.38 per cent, the worst first half for US equities since the Great Depression in 1932,” Mr Hollands says.
This is happening because central banks, led by the US Federal Reserve, are throwing monetary policy into a sharp reverse.
After decades of slashing interest rates and pumping out stimulus, they are tightening as fast as they dare to curb inflation.
“Central bankers have now yanked away the key supports for equity and bond markets that turbocharged them in 2020 and 2021,” Mr Hollands says.
Rising interest rates are bad news for shares because higher borrowing costs squeeze both businesses and consumers, hitting profits.
Bonds suffer because they pay a fixed rate of interest, which looks a lot less attractive when rates are rising and investors can earn higher yields elsewhere.
The stock and bond sell-off isn’t over yet despite signs of a recovery in recent days, says Fawad Razaqzada, market analyst at City Index and Forex.com.
Optimists convinced themselves that the Fed would curb rate increases for fear of tipping the US into recession, but this is a misreading.
“The Fed is in a hawkish mood. I think the start of another equity and bond market sell-off is nigh,” Mr Razaqzada says.
It is not all bad news, though.
Bonds do this odd thing that sometimes confuses private investors. When bond prices fall, yields rise.
While the bond price crash is bad news for existing holders, new bond investors are earning a higher rate of income. Yields on 10-year Treasuries have almost doubled from 1.63 per cent to 3.06 per cent this year.
Stock and bond market crashes have one thing in common. Both can throw up opportunities for forward-looking investors.
The Fed will continue to raise rates this year but it also wants room to cut when the US economy slips into recession as a result, probably in 2023, says Lisa Emsbo-Mattingly, managing director of asset allocation research at Fidelity Investments.
“If inflation comes down, real rates, which are yields minus the rate of inflation, could rise further into positive territory after being below zero for the past two years,” she says.
This would allow government bonds to carry out their old job of providing a steady level of income for lower-risk savers and pensioners. Bonds could then start making a meaningful contribution to that balanced 60/40 portfolio split again.
Bonds are cheaper than they were after this year’s dip and are starting to look better value for money.
It could soon be time to start buying bonds again, ideally before the Fed starts cutting rates next year to reverse the recession, at which point bond yields will fall again, Ms Emsbo-Mattingly says.
“But the window of opportunity for yield-seekers may be brief,” she says.
There are hundreds of bond ETFs to choose from, including iShares Core 1-5 Year USD Bond ETF, iShares Global Government Bond UCITS ETF (IGLO) or db x-trackers II Global Government Bond UCITS ETF.
Accurately timing bond fund purchases is no easier than timing the stock market, yet recent volatility is throwing up an opportunity.
MALAYSIA'S first Islamic bond (sukuk) for retail investors, launched yesterday and expected to be listed on February 8, will have a minimum profit rate of 3.7 per cent a year.
The RM300 million sukuk with a 10-year tenure was issued by DanaInfra Nasional Bhd, a unit under the Ministry of Finance, to fund the Mass Rapid Transit (MRT) project that will run between Kajang and Sungai Buloh in the Klang Valley. It was launched by Prime Minister Datuk Seri Najib Razak.
The issue is part of a larger RM1.5 billion sukuk that's being sold by DanaInfra, of which RM1.2 billion is for institutional investors.
"It will be better than the fixed deposit (FD) return and better than the MGS (Malaysian Government Securities, or government bonds)," Treasury secretary-general Datuk Seri Mohd Irwan Serigar Abdullah told reporters after the launch yesterday.
The average fixed deposit rate offered by commercial banks as at November last year was 3.15 per cent, according to Bank Negara Malaysia data, while the current yield for three-year government bonds is 3.04 per cent.
Bankers said the actual profit rate for the retail sukuk, which will depend on investor demand and the prevailing market interest rate, will be determined at the close of the book building exercise of the institutional offering.
Datuk Lee Kok Kwan of CIMB Investment Bank, one of four banks that are the joint lead arrangers for the issue, said he was confident that there would be strong demand for the retail sukuk.
He pointed out that unlike fixed deposit, income that investors derive from sukuk is not subject to tax.
"And the main assurance is that, post-listing, the liquidity will be there as the four banks are obligated to market them," he remarked.
Bursa Malaysia chief executive officer Datuk Tajuddin Atan said the retail sukuk, which opens up a new asset class for people to invest in, cements Malaysia's role as a top sukuk marketplace.
Previously, bonds or sukuk were accessible only to high-net worth and institutional investors.
"To make this sustainable, we need a pipeline, and this is being worked on. DanaInfra has a big pipeline of sukuk, but we're also looking at other issuers," he said.
The sukuk is meant for investors who want to diversify their portfolio. The minimum subscription amount for an ETBS is RM1,000, which will get an investor one board lot which comprises 10 units with a principal price of RM100 each.
Let's take a look at the bond table, and see how to break it down.
Column 1: Issuer. This is the company, state, province or country that is issuing the bond.
Column 2: Coupon. The coupon refers to the fixed interest rate that the issuer pays to the lender. The coupon rate varies by bond.
Column 3: Maturity Date. This is the date when the borrower will pay the principal back to the lenders (investors). Typically, only the last two digits of the year are quoted, so 25 means 2025, 04 is 2004, etc.
Column 4: Bid Price. This is the price that someone is willing to pay for the bond. It is quoted in relation to 100, regardless of the par value. Think of the bond price as a percentage, a bond with a bid of $93 means it is trading at 93% of its par value.
Column 5: Yield. The yield indicates the annual return until the bond matures. Yield is calculated by the amount of interest paid on a bond divided by the price -- it is a measure of the income generated by a bond. If the bond is callable it will have a "c" followed by the year in which the bond can be called. For example, c10 means the bond can be called as early as 2010.
It is a portfolio consisting of only 2 assets: stock and bond.
Here are some interesting points:
1. 100% in Stock This portfolio has the highest risk and also probability of the highest return.
2. 100% in Bond This portfolio has low risk (NOTE: NOT THE LOWEST) and has lower return.
3. 50% in Stock and 50% in Bond This portfolio has the same risk as and has higher return than the portfolio that is 100% in Bond.
4. 25% in Stock and 75% in Bond This portfolio has the lowest risk and has higher return than the portfolio that is 100% in Bond.
(You may assume that holding cash giving an interest rate of 3% is the equivalent of holding a bond with a coupon rate of 3%.)
Conclusion:
Holding 100% in bond carries the same risk as holding 50% in stock and 50% in bond. However, the probability of a higher return for the same risk should make investors favour holding 50% in stock and 50% in bondthan to hold 100% in bond.
For those who are very risk averse, for example in the present falling market, the lowest risk is the portfolio that is 25% stock and 75% bond, and not the portfolio that is 100% in bond. Moreover, the portfolio that is 25% stock and 75% bond, offers a probability of higher return for lower risk, that the portfolio with 100% in bond.
Investing isn't easy, but the important parts are simple.
Buy an asset when it's expensive, and future returns will likely be low.
Buy cheap, and you'll probably do all right.
There are ups and downs and booms and busts and lost decades throughout, but a basic appreciation of how valuation dictates the future can go a long way.
Stocks or Bonds: The Easy Choice
No one knows what any market will do in the future. But with hundreds of billions of dollars pouring into bonds and 10-year Treasuries yielding 1.5%, it's worth taking a peek at what history says about the past. This quote, from The Economist, seems particularly relevant: "Investors who bought Treasury bonds at a 2% yield in 1945 earned a negative real annual return of 2.3% over the following 35 years."
Investing isn't easy, but the important parts are simple. Buy an asset when it's expensive, and future returns will likely be low. Buy cheap, and you'll probably do all right. There are ups and downs and booms and busts and lost decades throughout, but a basic appreciation of how valuation dictates the future can go a long way. It also shows why bonds produced such dreadful returns after 1945.
In the 1940s, interest rates had been falling for the better part of 20 years as the Great Depression drove knee-jerk risk aversion, and hit record lows as various policies and incentives moved to cheaply finance wartime deficits. According to Yale economist Robert Shiller, 10-year Treasuries yielded 5% in 1920, 3% by 1935, and 2% by the early 1940s. The consensus came to believe low rates were a permanent fixture. "Low Interest Rates for Long Time to Come," read one newspaper headline in 1945.
But as the saying goes, if something can't go on forever, it won't. By 1957, 10-year Treasuries yielded 4%. By 1967, 5%. They breached 8% in 1970, and zoomed to 15% by 1981 as inflation scorched the economy. Since bond prices move in the opposite direction of interest rates, this was devastating to returns. Deutsche Bank has an archive of Treasury returns in real (after inflation) terms, which tells the story:
Period
Average Annual Real Returns, 10-Year Treasuries
1940-1949
(2.5%)
1950-1959
(1.8%)
1960-1969
0.2%
1970-1979
(1.2%)
Source: Deutsche Bank Long Term Asset Return Study.
Don't underappreciate how awful this was. In real terms, $1,000 invested in 10-year Treasuries in 1940 would have been worth $584 by 1979 -- this for an investment often trumpeted as "risk-free."
No one knows if the same performance will be repeated over the coming years. Japan is a good example of extremely low interest rates sticking around for decades. But the risks are obvious. With 10-year Treasuries yielding 1.5%, there is virtually no chance of high returns over the next decade. The odds of being hammered and suffering negative real returns are, however, quite good.
How about stocks? Here, too, no one knows what the future will bring. But history has an opinion.
The same Deutsche Bank study mentioned above shows that, after inflation, stocks produced an average annual return of negative 3.4% a year from 2000 to 2009. That was the third time since 1820 that stocks underwent a decade of negative real returns. Even during the Great Depression years of 1930-1939, stocks squeezed out a positive return.
Something else that sticks out from the study's nearly 200 years of history: Stocks have never produced back-to-back decades of negative real returns. Big booms have invariably followed long slumps. Stocks logged negative real returns during the 1910s, and followed up with blistering 16% real returns in the following decade. Returns went negative again during the 1970s, then shot to nearly 12% a year in the 1980s.
That may just be a quirk of the calendar. What matters are valuations. One of the best ways to measure the overall market's value is Robert Shiller's CAPE ratio, which calculates market price divided by 10 years' average earnings, adjusted for inflation. Its current value is 21, compared with an average of 19 since the S&P 500 began in 1957. So that's a little high. But here is where stocks' long-term superior gains come into play. Since 1880, the average 10-year return after CAPE at current levels is 7.7% a year, or about 5% a year after inflation. That's nothing to write home about, but it's almost certainly better than you'll achieve in bonds these days.
Unlike bonds, there are several good, high-quality stocks with long track records that can be purchased today at prices that set you up to earn decent future returns. A few I like areProcter & Gamble (NYSE: PG) , Colgate-Palmolive (NYSE: CL) , and Johnson & Johnson (NYSE: JNJ) .
Stock investments are superior to investment in bonds, despite the general view that bonds investments are relatively low-risk, according to the world’s most successful investor, Warren Buffett.
Speaking at a conference for top US businesswomen organised by Fortune magazine, Buffett said of stocks investments: “It’s quite clear that stocks are cheaper than bonds. I can’t imagine anyone having bonds in their portfolio when they can have equities.”
For the world’s 3rd-richest man, with a personal net worth estimated at $47 billion in March 2010, low-risk investments may no longer be necessary – but even for the ordinary investor prepared to put their money away for a decade or two, the arguments for stocks and shares investments are what Buffett might call a ‘no-brainer’.
By charting the performance of a long-term investment in stocks and shares made in 1945, figures released recently by Scottish Widows shows that returns over a 60-year term were 70 times greater than investing the same sum as cash in a bank or building society account.
A sum of £100 invested in a building society account in 1945 would have been worth just £1,767 by 2006, according to Scottish Widows. Invested in bonds, the sum would have been worth £4,323.
However, the same £100 invested in the UK stock markets, as measured by the Barclays Equity Index and including dividends reinvested, would have grown to £125,243 over the same time period.
While bonds may be attractive for an investment of 5-10 years, as you are told in advance what your minimum return will be, stocks and shares investments are the clear winner in the longer term.
Warren Buffett’s investment activities are carried on through his investment company Berkshire Hathaway, which has been voted the world’s most respected company by the leading US business publication Barron’s Magazine.
Risk was the chance that you might not meet your long-term investment goals.
And the greatest enemy of reaching those goals: inflation.
Nothing is safe from inflation.
It's major victims are savings accounts, T-bills, bonds, and other types of fixed-income investments.
Investors usually use Treasury bills as their benchmark for risk. These are considered risk-free because their nominal value can't go down. However, T-bills and bonds are in fact highly riskybecause of their susceptibility to inflation.
Realistic definition of Risk
A realistic definition of risk recognizes the potential loss of capital throughinflation and taxes,and includes:
1. The probability your investment will preserve your capital over your investment time horizon.
2. The probability your investments will outperform alternative investments during the period.
Short-term stock price volatility is not risk. Avoid investment advice based on volatility.
So if volatility is not risk, what is your major risk?
The major risk is not the short-term stock price volatility that many thousands of academic articles have been written about.
Rather it is the possibility of not reaching your long-term investment goal through the growth of your funds in real terms.
To measure monthly or quarterly volatility and call it risk - for investors who have time horizons 5, 10, 15 or even 30 years away - is a completely inappropriate definition. (David Dreman)
Take Home Lesson
Using Dreman's definition of risk, stocks are actually the safest investment out there over the long term.
Investors who put some or most of their money into bonds and other investments on the assumption they are lowering their risk are, in fact, deluding themselves.
"Indeed, it goes against the principle we were taught from childhood - that the safest way to save was putting our money in the bank."
