Interest rate risks for the overall Malaysian banking system is low.

 

Is SVB a canary in the coal mine?

Clearly, the situation is quite different in Malaysia. For starters, pandemic cash handouts were far smaller and, while deposits also rose during the pandemic — owing to loan moratoriums and lower spending — it was nowhere near the scale of that in the US. Total deposits increased from RM1.968 trillion to RM2.186 trillion between March 2020 and March 2022, or equivalent to just about 11% growth (see Chart 2).

And while investments in government and corporate bonds also rose at the outset of the pandemic — as a result of excess deposits and lower loan demand — the increase was small, from 17.9% in January 2020 to a high of 19.7% of total assets in August 2021. Currently, the average bond holdings among Malaysian banks is 19.1% of total assets, or about RM645.2 billion, compared with 24% in the US banking system. Of note, 90% of the total are made up of local bonds — only 10% of which are foreign currency denominated bonds (see Chart 3).

Bank Negara’s tempered OPR hikes limit interest rate risks for banking system …

More importantly, Bank Negara Malaysia has raised the overnight policy rate (OPR) by only 1%, from 1.75% to 2.75% over the same period (compared with the 4.75% hike in the US FFR). Yields for the benchmark 10-year Malaysia Government Securities (MGS) have risen by even less — from 3.6% at the start of 2022 to 3.88% currently. The yield differential is less than 0.3%. This means the drop in value for 10-year MGS is only about 2.3%, based on our back-of-the-envelope calculations (see Table 2).

This is a huge difference compared to the 15.3% drop in value for the 10-year Treasury. Furthermore, unrealised losses for shorter duration bonds will be much lower. For instance, more than half of Maybank’s bond holdings have durations of less than five years.

In short, total unrealised losses for local banks should be much lower. (Incidentally, the majority of loans [79%] are based on floating interest rates, which are repriced immediately on Bank Negara’s policy rate changes.) Therefore, we think interest rate risks for the overall Malaysian banking system is low. Naturally, some banks will be affected more than others. For instance, Maybank, CIMB, Hong Leong Bank, Ambank, Affin Bank and RHB Bank have a higher percentage of bonds on their balance sheets compared with banks such as Public Bank, Bank Islam, Alliance Bank and MBSB. This could be due to a combination of factors, including deposit inflows, the ability to make loans and the target customer market.

https://www.theedgemarkets.com/node/662043

How bonds with negative yields work and why this growing phenomenon is so bad for the economy

PUBLISHED WED, AUG 7 2019


KEY POINTS

About a quarter of the global bond market, or about $15 trillion worth of bonds, offer negative interest rates.

U.S. bonds are still paying something, but could go negative if there’s a recession.

Negative interest rates encourage government borrowing.





Imagine if I came to you with a deal.  Give me $10 today and I’ll return $9 to you in a decade or so.
No way right?  This is happening all around the world and on increasing basis.

Maybe you didn’t go to Harvard Business School, but perhaps you recall an early lesson from your Junior Achievement class that tells you this is not how it’s supposed to work.

You are supposed to put your money in the bank and be rewarded with interest. This is supposed to be wiser than trading your precious allowance at the candy store for an awesome, yet fleeting sugar rush.

Nicholas Colas, co-founder of DataTrek, put it plainly enough: “Bonds are supposed to pay the owner of capital something to pry the money out of their hands.”

Nevertheless, some really smart investors around the world now have invested about $15 trillion in government bonds that offer negative interest rates, according to Deutsche Bank. That represents about a quarter of the global bond market.


This financial insanity is overtaking the world because bond prices are skyrocketing as stock prices are tanking. As more money flows into bonds, their yields go down — even below zero in some cases.

The good news is that U.S. Treasurys, while hovering near all-time lows, still pay at least something. The 10-year was yielding 1.62 percent on Wednesday. Still, that’s low enough to stymie financial educators as they try to convince children that they should put off instant gratification and save at least some of their allowances.

Some market observers are now warning that the U.S. could be paying negative bond rates, too, if there’s another recession. Currently, our central bank, the Federal Reserve, has set its benchmark rate at 2.25%. When the economy turns south, the Fed typically lowers rates by as much as 5 percentage points to reignite borrowing and spending.

But where else can it go after it hits zero?

Paying any government to take your money is as irresponsible as feeding children nothing but candy bars. It’s what you might call a “moral hazard,” but this term seems to have been eliminated from the economics texts following the bailouts of reckless financial institutions in the 2008 financial crisis.

Negative interest rates, and even super-low interest rates, are only going to encourage more government borrowing. This in turn allows politicians to make all kinds of grandstanding promises — until one day when the debt pile gets too big, interest rates return to historically normal levels, and taxes go up to pay for it all.

So why does this happen?

Institutional money have investing guidelines they have to follow while shepherding all their billions. Those guidelines often require them to buy bonds. The demand for these bonds is rising sharply — so they take the deal of the day.

In the end, it’s not a good sign for the economy.



https://www.cnbc.com/2019/08/07/how-bonds-with-negative-yields-work-and-why-this-growing-phenomenon-is-so-bad-for-the-economy.html?__source=facebook%7Cmain&fbclid=IwAR15vbqWZbZc1qxFjw4gZscoU7Z2u7kcRKe5m7qGSWwD0q80RSwEWJxqRBs

"Gentlemen who prefer bonds don't know what they've missing."

Theoretically, it makes no sense to put any money into bonds, even if you do need income.

Take the case of a asset allocation of 50 percent of the money invested in stocks that grow at 8% and 50 percent in bonds that don't appreciate at all, the combined portfolio had a growth rate of 4 percent - barely enough to keep up with inflation.

What would happen if we adjusted the mix?

By owning more stocks and fewer bonds, you would sacrifice some current income in the first few years.  But this short-term sacrifice would be more than made up for by the long-term increase in the value of the stocks, as well as by the increases in dividends from those stocks.  

Since dividends continue to grow, eventually a portfolio of stocks will produce more income than a fixed yield from a portfolio of bonds. 

Peter Lynch



Additional notes:

1.  Once and for all, we have put to rest the last remaining justification for preferring bonds to stocks - that you can't afford the loss in income.
2.  But here again, the fear factor comes into play.
3.  Stock prices do not go up in orderly fashion, 8 percent a year.  Many years, they even go down.
4.  The person who uses stocks as substitute for bonds not only must ride out the periodic corrections, but also must be prepared to sell shares, sometimes at depressed prices, when he or she dips into capital to supplement the dividend.
5.  This is especially difficult in the early stages, when a setback for stocks could cause the value of the portfolio to drop below the price you paid for it.
6.  People continue to worry that the minute they commit to stocks, another BIG ONE will wipe out their capital, which they can't afford to lose.
7.  This is the worry that will keep you in bonds, even after you've studied and are convinced of the long-range wisdom of committing 100% of your money to stocks.


Let's assume, that the day after you've bought all your stocks, the market has a major correction and your portfolio loses 25% of its value overnight.
1.  You berate yourself for gambling away the family nest egg, but as long as you don't sell, you're still better off than if you had bought a bond.
2.  Computer run simulation shows that 20 years later, your portfolio will be worth $185,350 or nearly double the value of your erstwhile $100,000 bond.

Or, let's imagine an even worse case:  a severe recession that lasts 20 years, when instead of dividends and stock prices increasing at the normal 8 percent rate, they do only half that well.
1.  This would be the most prolonged disaster in modern finance.
2.  But, if you stuck with the all-stock portfolio, taking out your $7,000 a year, in the end you'd have $100,000.  This still equals owning a $100,000 bond.

Ref:  Pg 55 Beating the Street, by Peter Lynch.


FOR YOUR IMMEDIATE ACTION!!!

1.  TALK YOURSELF OUT OF OWNING ANY BONDS.
2.  AT LEAST, YOU SHOULD DECIDE TO INCREASE THE PERCENTAGE OF ASSETS INVESTED IN STOCKS, WHICH IS A STEP IN THE RIGHT DIRECTION.

Bargain-Issue Pattern in Secondary Companies (2): How to profit from these bargains?

Bargains in stocks of Secondary Companies

If secondary issues tend NORMALLY to be undervalued, what reason has the investor to hope that he can profit by such a situation?

For if this undervaluation persists indefinitely, will he not always be in the same position market wise as when he bought the issue?

The answer here is somewhat complicated.

Substantial profits from the purchase of secondary companies at bargain prices arise in a variety of ways.

1. First, the dividend return is high.
2. Second, the reinvested earnings are substantial in relation to the price paid and will ultimately affect the price.  In a five- to seven-year period these advantages can bulk quite large in a well-selected list.
3. Third, when a bull market appears, it is most generous to low-priced issues; thus it tends to raise the typical bargain issue to at least a reasonable level.
4. Fourth, even during relatively featureless market periods a continuous process of price adjustment goes on, under which secondary issues that were undervalued may rise at least to the normal level for their type of security.

An illustration of performance of undervalued securities (bargains companies)

Performance of two groups of undervalued securities selected at the beginning of 1940.

(Reference:  pp 689 and 690 of Security Analysis, by Graham and Dodd, 1940 Edition)

                                               (Excluding Dividends Received)

                                         Market Price                            Market Price

                                         Dec 31, 1939                           Dec 31, 1947

Group A 

10 Stocks

Total                                 120 5/8                                    449

Group B

10 Stocks     

Total                                  115                                         367 7/8

Total of Both Groups        236                                         817 
                                                                                         INCREASE 246%

Observations and Inferences/Conclusions

This performance is superior not only to that of the Dow-Jones list but to that of the growth-stock list as well.

Allowance should be made for the fact, that nearly all the smaller companies benefited more from the war than did the bigger ones.  

The figures, thus, prove without a doubt that under favourable conditions, bargain issues can yield a handsome profit.

His experience over many years led Benjamin Graham to assert that the average results from this area of activity are satisfactory.

Overview of a Fixed-Income Security (Bonds)

Who are the issuers of fixed-income security or bonds?

• Supranational organizations
• Sovereign (national) governments
• Non-sovereign (local) governments
• Quasi-government entities

Credit worthiness of Bonds

Bond issuers can also be classified based on their credit worthiness as judged by credit rating agencies.

Bonds can broadly be categorized as

• investment-grade bonds or
• non-investment grade (or high yield or speculative) bonds.

Maturity of Bonds

Fixed-income securities which, at the time of issuance, are expected to mature in one year or less are known as money market securities.

Fixed-income securities which, at the time of issuance, are expected to mature in more than one year are referred to as capital market securities.

Fixed-income securities which have no stated maturity are known as perpetual bonds.

Par Value

The par value (also known as face value, nominal value, redemption value and maturity value ) of a bond refers to the principal amount that the issuer promises to repay bondholders on the maturity date.

Bond prices are usually quoted as a percentage of the par value.

• When a bond's price is above 100% of par, it is said to be trading at a premium
• When a bond's price is at 100% of par, it is said to be trading at par.
• When a bond's price is below 100% of par, it is said to be trading at a discount.

Coupon Rate and Frequency

The coupon rate (also known as the nominal rate) of a bond refers to the annual interest rate that the issuer promises to pay bondholders until the bond matures.

The amount of interest paid each year by the issuer is known as the coupon, and is calculated by multiplying the coupon rate by the bond's par value.

Zero-coupon (or pure discount) bonds are issued at a discount to par value and redeemed at par (the issuer pays the entire par amount to investors at the maturity date).  The difference between the (discounted) purchase price and the par value is effectively the interest on the loan.

Currency Denomination

Dual currency bonds make coupon payments in one currency and the principal payment at maturity in another currency.

Currency option bonds give bondholders a choice regarding which of the two currencies they would like to receive interest and principal payments in.

Yield Measures

The current yield or running yield equals the bond's annual coupon amount divided by its current price (not par value), expressed as a percentage.

The yield to maturity (YTM) is also known as the yield to redemption or the redemption yield.  It is calculated as the discount rate that equates the present value of a bond's expected future cash flows until maturity to its current price.

Given a set of expected future cash flows, the lower  the YTM or discount rate, the higher the bond's current price.

Given a set of expected future cash flows, the higher the YTM or discount rate, the lower the bond's current price.

Important Relationships of Fixed Income Securities (Bonds)

Defining the Elements of a Bond

Coupon rates and bond prices

The higher the coupon rate on a bond, the higher its price.

The lower the coupon rate on a bond, the lower its price.


Interest rates and bond prices

An increase in interest rates or the required yield on a bond, will lead to a decrease in price.

A decrease in interest rates or the required yield on a bond will lead to an increase in price.

That is, bond prices and yields are inversely related.


Bonds risks and bond yields 

The more risky the bond, the higher the yield required by investors to purchase the bond, and the lower the bond's price.

Why anyone would buy a 30-year bond 'absolutely baffles me,' Warren Buffett says

Billionaire investor Warren Buffett told CNBC he can't see any reason for investors to buy 30-year bonds right now.

"It absolutely baffles me who buys a 30-year bond, the chairman and CEO of Berkshire Hathaway said on "Squawk Box" on Monday. "I just don't understand it."

"The idea of committing your money at roughly 3 percent for 30 years ... doesn't make any sense to me," he added.

Buffett said he wants his money in companies, not Treasurys — making the case throughout CNBC's three-hour interview that he sees stocks outperforming fixed income.

Click here for the video

http://www.cnbc.com/2017/02/27/buffett-doesnt-understand-30-year-bond-appeal.html

Buffett: Measured against interest rates, stocks are actually on the cheap side compared to historic valuations.

BUFFETT ON BONDS

WHEN RATES HAVE BEEN WHERE THEY HAVE BEEN THE LAST FIVE OR SIX YEARS OR EVEN LONGER, SELLING VERY LONG BONDS MAKES SENSE FOR THE SAME REASON I THINK IT'S DUMB TO BUY THEM. I WOULDN'T BUY 50 YEAR BOND IN A MILLION YEARS AT THESE RATES IF IT'S THAT DUMB FOR ME TO BUY IT, ITS PROBABLY PRETTY SMART FOR THE ENTITY TO SELL THEM. IF I AM RIGHT. SO I WOULD SAY THE TREASURY – THERE'S A LOT OF CONSIDERATIONS THEY HAVE, BUT I WOULD BE SHOVING OUT LONG BONDS.

BUFFETT ON BUYING CONSISTENTLY

THE BEST THING WITH STOCKS ACTUALLY IS TO BUY THEM CONSISTENTLY OVER TIME. YOU WANT TO SPREAD THE RISK AS FAR AS THE SPECIFIC COMPANIES YOU'RE IN BY OWNING A DIVERSIFIED GROUP AND YOU DIVERSIFY OVER TIME. BY BUYING THIS MONTH, NEXT MONTH, THE YEAR AFTER, THE YEAR AFTER, THE YEAR AFTER. YOU'RE MAKING A TERRIBLE MISTAKE IF YOU STAY OUT OF A GAME YOU THINK IS GOING TO BE VERY GOOD OVER TIME BECAUSE YOU THINK YOU CAN PICK A BETTER TIME TO ENTER IT.

BUFFETT ON NO BUBBLE

AND WE ARE NOT IN A BUBBLE TERRITORY. OR ANYTHING OF THE SORT. IF INTEREST RATES WERE 7 OR 8%, THEN THESE PRICES WOULD LOOK EXCEPTIONALLY HIGH. BUT YOU HAVE TO MEASURE – YOU MEASURE EVERYTHING AGAINST INTEREST RATES BASICALLY. AND INTEREST RATES ACT LIKE GRAVITY ON VALUATION.

BUFFETT ON STOCKS CHEAP

MEASURED AGAINST INTEREST RATES, STOCKS ACTUALLY ARE ON THE CHEAP SIDE COMPARED TO HISTORIC VALUATIONS. BUT THE RISK ALWAYS IS THAT INTEREST RATES GO UP A LOT AND THAT BRINGS STOCKS DOWN. BUT I WOULD SAY THIS, IF THE TEN YEAR STAYS AT 230 AND WOULD STAY THERE FOR 10 YEARS, YOU WOULD REGRET VERY MUCH NOT HAVING BOUGHT STOCKS NOW.

http://www.cnbc.com/2017/02/27/cnbc-excerpts-billionaire-investor-warren-buffett-speaks-with-cnbcs-becky-quick-on-squawk-box-today.html

How Wall Streets can create investment fads? The Junk Bond Market of mid-1980s

How the Wall street created the junk bond market investment fads?

In the early to mid-1980's, Wall Street firms pushed junk bonds on investors.

They touted the positive historical results of high-yield debt. 

There were major differences between the debts of fallen angels versus newly issued bonds from fragile companies.

Debt from fallen angels:

•  trades at a discount to par, 
• downside risk is reduced. 
• at the same time, the potential for capital appreciation is large. 

Newly issued debt from marginal companies 

• does not share in these above characteristics.

How Wall Street can create investment fads, only to leave investors much poorer when the tide goes out.

That didn't stop Wall Street from pushing this form of debt (newly issued debt from marginal companies), nor did it stop investors from ponying up and falling victim to these issues.

The number and size of junk bond issues grew, despite the fact that this asset class was untested by an economic downturn, which should have made investors cautious. 

Investors were happy to gobble up zero coupon bonds (where the interest accrues to the issuer but is not paid out until the bond comes due) despite the clear risks! 

It took the downturn of the early nineties to wipe out those who were too eager to pay for assets that were risky.



Faulty Logic using EBITDA propelled the Speculation

One way investors were prodded into purchasing such securities were valuation measures based on EBITDA. 

Rather than considering cash flow or earnings, companies were valued using this accounting measure which doesn't include depreciation expenses. 

A company paying its debts from EBITDA is slowly liquidating itself (as it can't make capital expenditures) and leaving itself susceptible to a credit crunch.

Such fads will undoubtedly occur in the future, and those who are able to avoid them will do well.

Read also:

• 
  
• Your investments using Mutual Funds or Money Managers
• Trading and portfolio management from a value investing point of view
• Value Investor's Opportunities in Distressed Securities
• Value Investing Opportunities in the Banking Sector
• Look at FUNDAMENTALS and POTENTIAL CATALYSTS when making investment decisions
• Where to look for Investment Opportunities
• Business value cannot be precisely determined. Make use of ranges of values
• Central elements to a Value Investing Philosophy
• The Philosophy of Value Investing and Why It Works
• Philosophy of value investing. Need to have clear strategies too
• How Wall Streets can create investment fads? The Junk Bond Market of mid-1980s
• Understanding these changes in the investment world allows investors to earn superior returns
• What's good for Wall Street is not necessarily good for investors
• Speculators, Investors and Market Fluctuations

Stocks and Bonds

The balance sheet helps us understand the overall financial health of a company.

A major factor in determining financial health is the company's underlying capital structure.

What is the best way to capitalize a company?  Is it equity or debt?  The answer is that it depends, as both debt and equity have their advantages.


Debt

Debt offers the following advantages.

1.   Lenders have no direct claim on future earnings.  Debt can be issued without worries about a claim on earnings.  As long as the interest is paid, the company is fine.

2.  Interest paid on debt can be deducted for tax purposes.

3.  Most payments, whether they are interest or principal payments, are usually predictable, and so a company can plan ahead and budget for them.

4.  Debt does not dilute the owner's interest, and so an owner can issue debt and not worry about a reduced equity stake.

5.  Interest rates are usually lower than the expected return.  If they are not, a change in management can be expected soon.



Debt securities can take a number of different forms, the most common being bonds.

Bonds are obligations secured by a mortgage on company property

Bonds tend to be safer from the investors' standpoint and therefore pay lower interest.

Debentures, in contrast, are unsecured and are issued on the strength of the company's reputation, projected earnings, or growth potential.

Debentures, being far riskier, tend to pay more interest than do their more secure counterparts.




Equity

Equity has the following advantages:

1.  Equity does not raise a company's break-even point.  A company can issue equity and not have to worry about achieving performance benchmarks to fund the equity.

2.  Equity does not increase the risk of insolvency, and so a company can issue equity and not have to worry about any subsequent payments to service that equity.  Equity is essentially capital with unlimited life and so a company can issue equity and not have to worry about when it comes due.

3.  There is no need to pledge assets or offer by personal guarantees when equity is issued.



Equity can take a number of different forms.

A simple form of equity is common stock.

This type of stock offers no limits on the rate of return and can continue to rise in price indefinitely.

There are no fixed terms; the stock is issued and the holder bears the stock.

Preferred stock entitles the holders to receive dividends at a fixed or adjustable rate of return and ranks higher than common stock in a liquidation.

Preferred stock may have anti-dilution rights so that in a subsequent stock offering, preferred stockholders may maintain the same equity stake.

Convertible securities are highly structured in nature and are based on certain parameters.  As the word convertible indicates, they may convert into other securities.

Among the most common are warrants and options.

Warrants and options stand for the right to buy a stated number of shares of common or preferred stock at a specified time for a specified price.

There are also convertible notes and preferred stock, which refer to the right to convert these notes to some common stock when the conversion price is more favourable than the current rate of return.

"Gentlemen who prefer bonds don't know what they've missing."

Theoretically, it makes no sense to put any money into bonds, even if you do need income.

Take the case of a asset allocation of 50 percent of the money invested in stocks that grow at 8% and 50 percent in bonds that don't appreciate at all, the combined portfolio had a growth rate of 4 percent - barely enough to keep up with inflation.

What would happen if we adjusted the mix?

By owning more stocks and fewer bonds, you would sacrifice some current income in the first few years.  But this short-term sacrifice would be more than made up for by the long-term increase in the value of the stocks, as well as by the increases in dividends from those stocks.  

Since dividends continue to grow, eventually a portfolio of stocks will produce more income than a fixed yield from a portfolio of bonds. 


Peter Lynch



Additional notes:

1.  Once and for all, we have put to rest the last remaining justification for preferring bonds to stocks - that you can't afford the loss in income.
2.  But here again, the fear factor comes into play.
3.  Stock prices do not go up in orderly fashion, 8 percent a year.  Many years, they even go down.
4.  The person who uses stocks as substitute for bonds not only must ride out the periodic corrections, but also must be prepared to sell shares, sometimes at depressed prices, when he or she dips into capital to supplement the dividend.
5.  This is especially difficult in the early stages, when a setback for stocks could cause the value of the portfolio to drop below the price you paid for it.
6.  People continue to worry that the minute they commit to stocks, another BIG ONE will wipe out their capital, which they can't afford to lose.
7.  This is the worry that will keep you in bonds, even after you've studied and are convinced of the long-range wisdom of committing 100% of your money to stocks.


Let's assume, that the day after you've bought all your stocks, the market has a major correction and your portfolio loses 25% of its value overnight.
1.  You berate yourself for gambling away the family nest egg, but as long as you don't sell, you're still better off than if you had bought a bond.
2.  Computer run simulation shows that 20 years later, your portfolio will be worth $185,350 or nearly double the value of your erstwhile $100,000 bond.

Or, let's imagine an even worse case:  a severe recession that lasts 20 years, when instead of dividends and stock prices increasing at the normal 8 percent rate, they do only half that well.
1.  This would be the most prolonged disaster in modern finance.
2.  But, if you stuck with the all-stock portfolio, taking out your $7,000 a year, in the end you'd have $100,000.  This still equals owning a $100,000 bond.

Ref:  Pg 55 Beating the Street, by Peter Lynch.


FOR YOUR IMMEDIATE ACTION!!!

1.  TALK YOURSELF OUT OF OWNING ANY BONDS.
2.  AT LEAST, YOU SHOULD DECIDE TO INCREASE THE PERCENTAGE OF ASSETS INVESTED IN STOCKS, WHICH IS A STEP IN THE RIGHT DIRECTION.

Alternative Investments and Price-Value Relationships

Alternative investments to equities both illustrate the universality of value investing principles and reinforce the key element of relating price to value.  Below summarizes some alternatives to equities and their price-value relationship.

Straight Bonds:  Duration and coupon drive valuation and price.

Convertible Bonds:  Equity component drives variability, some price-value divide.

Real Estate:  Buyers intuit a price-value divide when seeking ":good deals".

Precious Metals:  Supply-demand imbalances drive price-value divide

Other Collectibles:  Personal attachments drive price-value divide


Value investors habitually relate price to value.  This attitude applies not only to equities, but also to all other investments.  The habit of relating price and value comes more naturally for certain assets than others.

Real estate is a good example.  People seem intuitively able to understand that they might be getting a "good deal" on real estate, but many exhibit less intuition when thinking about common stock investments.  They do likewise with consumption goods such as cares and loans or leases taken to finance their purchase.

Markets for some alternatives show how price-value differences are less likely to appear.  Bonds are a good example.  These instruments have features such as duration and interest rate that common stocks lack.  This makes it easier for investors to agree on their value and produces prices more reflective of value.  The absence of these features on common stocks suggests reasons to believe that price-value differences are likely to occur on common stocks.

in·tu·i·tion 

Noun The ability to understand something immediately, without the need for conscious reasoning. A thing that one knows or considers likely from instinctive feeling rather than conscious reasoning.

Synonyms insight - instinct

Benjamin Graham: Mutual Funds

Graham, Chapter 9:

Mutual funds are the subject of the ninth chapter of The Intelligent Investor. Fund performance and the different types of funds available to the investor are covered. 

One of those types of funds is the performance fund, which seeks to outperform the Dow Jones Industrial Average in this case, so they are the more aggressive of the funds. 

Another type, the closed-end fund only offers a specific number of shares at one time, instead of continuously, and is the most illiquid of the bunch. 

The last mutual fund type Graham mentions in this chapter is the balanced fund. These types of funds contain a certain percentage of bond holdings. Even the conservatively investing Graham suggests you would be better off investing in bonds by themselves, rather than mixed in a fund with stocks.

The Intelligent Investor by Benjamin Graham

How do governments go bust?

 Solutions:

1. Raise taxes

2. Cut spending

3. "Printing money" / Bailout

Stock investments versus bonds are a ‘no-brainer’, says Warren Buffett

October 6th, 2010 by John Doherty

 

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.

http://www.principlefirst.co.uk/investment-news/stock-investments-versus-bonds-are-a-nobrainer-says-warren-buffett/

The Risks of Bond Investing: Understanding Dangers in Fixed-Income Investing

There's no such thing as a sure thing, even in the bond world

From Paul Conley, former About.com Guide

Bonds are among the safest investments in the world. But that hardly means that they’re risk free. Here’s a look at some of the dangers inherent in fixed-income investing.

• Inflation Risk: Because of their relative safety, bonds tend not to offer extraordinarily high returns. That makes them particularly vulnerable when inflation rises.
  Imagine, for example, that you buy a Treasury bond that pays interest of 3.32%. That’s about as safe an investment as you can find. As long as you hold the bond until maturity and the U.S. government doesn’t collapse, nothing can go wrong….unless inflation climbs. If the rate of inflation rises to, say, 4 percent, your investment is not “keeping up with inflation.” In fact, you’d be “losing” money because the value of the cash you invested in the bond is declining. You’ll get your principal back when the bond matures, but it will be worth less.
  Note: there are exceptions to this rule. For example, the Treasury Department also sells an investment vehicle called Treasury Inflation-Protected Securities.
• Interest rate risk: Bond prices have an inverse relationship to interest rates. When one rises, the other falls.
  If you have to sell a bond before it matures, the price you can fetch will be based on the interest rate environment at the time of the sale. In other words, if rates have risen since you “locked in” your return, the price of the security will fall.
  All bonds fluctuate with interest rates. Calculating the vulnerability of any individual bond to a rate shift involves an enormously complex concept called duration. But average investors need to know only two things about interest rate risk.
  First, if you hold a security until maturity, interest rate risk is not a factor. You’ll get back the entire principal upon maturity.
  Second, zero-coupon investments, which make all their interest payments when the bond matures, are the most vulnerable to interest rate swings.
• Default Risk: A bond is nothing more than a promise to repay the debt holder. And promises are made to be broken. Corporations go bankrupt. Cities and states default on muni bonds. Things happen...and default is the worst thing that can happen to a bondholder.
  There are two things to remember about default risk.
  First, you don’t need to weigh the risk yourself. Credit ratings agencies such as Moody’s do that. In fact, bond credit ratings are nothing more than a default scale. Junk bonds, which have the highest default risk, are at the bottom of the scale. Aaa rated corporate debt, where default is seen as extremely unlikely, is at the top.
  Second, if you’re buying U.S. government debt, your default risk is nonexistent. The debt issues sold by the Treasury Department are guaranteed by the full faith and credit of the federal government. It’s inconceivable that the folks who actually print the money will default on their debt.
• Downgrade Risk: Sometimes you buy a bond with a high rating, only to find that Wall Street later sours on the issue. That’s downgrade risk.
  If the credit rating agencies such as Standard & Poor’s and Moody’s lower their ratings on a bond, the price of those bonds will fall. That can hurt an investor who has to sell a bond before maturity. And downgrade risk is complicated by the next item on the list, liquidity risk.
• Liquidity risk: The market for bonds is considerable thinner than for stock. The simple truth is that when a bond is sold on the secondary market, there’s not always a buyer. Liquidity risk describes the danger that when you need to sell a bond, you won’t be able to.
  Liquidity risk is nonexistent for government debt. And shares in a bond fund can always be sold.
  But if you hold any other type of debt, you may find it difficult to sell.
• Reinvestment Risk: Many corporate bonds are callable. What that means is that the bond issuer reserves the right to “call” the bond before maturity and pay off the debt. That can lead to reinvestment risk.
  Issuers tend to call bonds when interest rates fall. That can be a disaster for an investor who thought he had locked in an interest rate and a level of safety.
  For example, suppose you had a nice, safe Aaa-rated corporate bond that paid you 4% a year. Then rates fall to $2%. Your bond gets called. You’ll get back your principal, but you won’t be able to find a new, comparable bond in which to invest that principal. If rates have fallen to 2%, you’re not going to get 4% with a nice, safe new Aaa-rated bond.
• Rip-off Risk: Finally, in the bond market there’s always the risk of getting ripped off. Unlike the stock market, where prices and transactions are transparent, most of the bond market remains a dark hole.
  There are exceptions. And average investors should stick to doing business in those areas. For example, the bond fund world is pretty transparent. It only takes a tiny bit of research to determine if there is a load (sales commission) on a fund. And it only takes another few seconds to determine if that load is something you’re willing to pay.
  Buying government debt is a low-risk activity as long as you deal with the government itself or some other reputable institution. Even buying new issues of corporate or muni debt isn’t all that bad.
  But the secondary market for individual bonds is no place for smaller investors. Things are better than they once were. The TRACE (Trade Reporting and Compliance Engine) system has done wonders to provide individual bond investors with the information they need to make informed investing decisions.
  But you’d be hard-pressed to find any scrupulous financial advisor who would recommend that your average investor venture in to the secondary market on his own.
  
  
  http://bonds.about.com/od/bonds101/a/bondrisk.htm

Should investors switch from bonds to shares?

Savers have preferred bonds to shares for the past seven months. But those saving for long-term goals such as retirement should remember that equities, unlike bonds, can offer a growing income.

http://www.telegraph.co.uk/finance/personalfinance/investing/9290399/Should-investors-switch-from-bonds-to-shares.html

The Basics of Personal Finance Investing: Stocks, Bonds, and Short-term investments.

Overall, investing is a great way to build wealth or a 'nest egg' for your retirement. If you invest regular amounts of money on a consistent basis over a long period of time, you are more likely to be successful in reaching your financial goals. By knowing just a few investing basics, you can get started with a variety of income options.

Three Types Of Investments

There are three basic types of investments you can choose from. There are stocks, bonds, and short-term investments.

Stocks

Stocks can also be referred to as equity investments. These are investments in individual companies that are publicly held. Stocks allow you to hold a small ownership in these companies. When invested in long-term, stocks have a high potential for growth. Stocks are not without risk, however. If the price of the stock drops, so do the investor's earnings. If a company goes out of business, the owners of the stock can lose their entire investment. It is wise to invest in the stock of companies that have been around for a very long time and that have a track record of rising stock prices.

Bonds

Buying a bond is basically lending money to the company you are purchasing it from. An example of this is buying a bond from the U.S. Treasury. After purchase a bond, you would be paid back after you cash it in. Buying bonds has the potential to increase your wealth with a lower risk than purchasing stocks, as well as the benefit of having a bit of protection from economic inflation.

Short-Term Investments

Short term investments can include money market investments, certificates of deposit (CD's), and others. After a short period of time, you can earn interest on these investments. You can usually begin receiving interest in as little as one year or less. These short-term investments are much less risky than stocks and bonds, but there is lower potential for growth. This means you can not expect as large of a return on a short-term investment as you could from stocks or bonds.

Article Source: http://EzineArticles.com/1408204

The Basics of Personal Finance Investing
By Richard MacGrueber

Margin of Safety Concept in Bonds and Preferred Stocks (Fixed Value Investments)

In the old legend the wise men finally boiled down the history of mortal affairs into the single phrase, “This too will pass.”  Confronted with a like challenge to distill the secret of sound investment into three words, we venture the motto, MARGIN OF SAFETY. This is the thread that runs through all the preceding discussion of investment policy—often explicitly, sometimes in a less direct fashion. Let us try now, briefly, to trace that idea in a connected argument.

All experienced investors recognize that the margin-of-safety concept is essential to the choice of sound bonds and preferred stocks. 

For example, a railroad should have earned its total fixed charges better than five times (before income tax), taking a period of years, for its bonds to qualify as investment-grade issues. 

• This past ability to earn in excess of interest requirements constitutes the margin of safety that is counted on to protect the investor against loss or discomfiture in the event of some future decline in net income. 
• (The margin above charges may be stated in other ways — for example, in the percentage by which revenues or profits may decline before the balance after interest disappears—but the underlying idea remains the same.)
• The bond investor does not expect future average earnings to work out the same as in the past; if he were sure of that, the margin demanded might be small. 
• Nor does he rely to any controlling extent on his judgment as to whether future earnings will be materially better or poorer than in the past, if he did that, he would have to measure his margin in terms of a carefully projected income account, instead of emphasizing the margin shown in the past record. 
• Here the function of the margin of safety is, in essence, that of rendering unnecessary an accurate estimate of the future. 
• If the margin is a large one, then it is enough to assume that future earnings will not fall far below those of the past in order for an investor to feel sufficiently protected against the vicissitudes of time.

The margin of safety for bonds may be calculated, alternatively, by comparing the total value of the enterprise with the amount of debt. (A similar calculation may be made for a preferred-stock issue.) 

• If the business owes $10 million and is fairly worth $30 million, there is room for a shrinkage of two-thirds in value—at least theoretically—before the bondholders will suffer loss. 
• The amount of this extra value, or “cushion,” above the debt may be approximated by using the average market price of the junior stock issues over a period of years. 
• Since average stock prices are generally related to average earning power, the margin of “enterprise value” over debt and the margin of earnings over charges will in most cases yield similar results.

So much for the margin-of-safety concept as applied to “fixed value investments.” Can it be carried over into the field of common stocks? Yes, but with some necessary modifications.

Ref:  The Intelligent Investor by Benjamin Graham

CHAPTER 20 “Margin of Safety” as the Central Concept of Investment




Also read:

• Margin of Safety Concept in The Business Venture of Buying and Selling Stocks
• Margin of Safety Concept in Conventional and Unconventional Investments
• Margin of Safety Concept in Speculation and Investment
• Margin of Safety Concept in Diversification
• Margin of Safety Concept in Undervalued or Bargain Stockss
• Margin of Safety Concept in Growth Stocks
• Margin of Safety in Good-Quality and Low-Quality Stocks.
• Margin of Safety Concept in Common Stocks
• Margin of Safety Concept in Bonds and Preferred Stocks
• 
  

Valuation of Bonds and Shares

Valuation of Bonds and Shares

View more presentations from Biswajit Ghosh