Do property bubbles always lead to crises?

They will increase economic downturn risks, but Asians should not be too worried

MANY of the world’s biggest economic crises in recent years originated from property bubbles. The list includes the US “subprime” crisis (2008), Japan’s economic stagnation (1992 onwards); and the financial crisis in Sweden (1991), Finland (1991), Norway (1987) and Spain (1977).
They were all largely triggered by property bubbles popping.
Today, it is therefore understandable that investors are concerned about property bubbles in Asia, especially in China; how would the property bubble affect China’s economy, and by extension Asia’s and the world’s economy.
The important question today I believe is not whether major economic crises are usually triggered by property bubbles, but do property bubbles always lead to banking and economic crises.

Property bubbles certainly increase economic downturn risks, especially when they pop. However, we do not think it will always lead to a banking and economic crisis.
First, property bubble-induced economic crises occur largely because there is cheap money (i.e. low borrowing cost) and excessive bank lending, giving rise to investment frenzy, including speculation. When the bubble pops, banks’ non-performing loans (NPLs) rise, causing banks’ capital to be insufficient.
Confidence about banks’ financial health then comes into question, which may lead to a bank run. Banks are then forced to cut back on credit, which in turn affects the economy, turning the property price collapse into an economic crisis.
The key to see if a property bubble burst leads to an economic crisis or not is whether there is excessive lending (high margin, lax lending) and substantial lending (high total banking exposure to property).
One case in point is the China property bubble burst of 2008 where some house prices in Shenzhen dropped as much as 40% (yes, there was one, overshadowed by the much bigger US property bubble popping) but there was no banking crisis.
Surprisingly, NPLs of Chinese banks did not rise in 2008 (as one would expect when property bubbles burst); instead they continued to fall (China’s total bank NPLs have fallen from above 12% of total loans in 2004 to 1.4% in 2010).
Until today, China’s banks are relatively secure because many buyers are required to pay high down payments (from a minimum of 20% to 30% for first mortgage, to 40% to 50% for subsequent mortgages). This high commitment of home buyers partly explains the lower risk for banks and the low default rate of mortgages (NPLs for China banks in mortgage loans are traditionally low, now at about less than 1%).
Another example is high-end properties in Hong Kong and Singapore. While there is no doubt it is a property price bubble, the systemic risk to the banking system and economy is less because it is more prevalent to luxury properties, coupled with less excessive bank lending.

Second, the size (volume and price) of a property bubble determines the negative impact to the economy when it pops. To illustrate, if the price of a single property unit increases significantly and then crashes sharply, there is really little impact to the economy. However, if there were millions of such transactions built up over the years, chances are that when the bubble pops, it will have very severe damage to the economy.
In Asia, recent property bubbles had relatively short time to build. Take, for example, the high-end property bubbles in China, Hong Kong and Singapore, which started approximately from about 2006 before they tumbled in 2008.
Compared with the build-up for the last supersize property bubble of the US (estimate from 2001 to a collapse in 2008) or Japan (estimate from 1986 to 1991), the run-up in Asia’s property bubbles today (essentially from 2009) has perhaps less time to accumulate high numbers of property transactions to reach a supersize bubble.
For example, on Sept 30, 2006, US Federal Deposit Insurance Corp data showed real estate loans might be in excess of 40% of US banks’ total lending. As comparison, according to a PIMCO report in 2010, the share of loans in China’s real estate sector is less than 20% of total lending.
So, should we be worried about the impact of property bubbles bursting in Asia, bringing Asian economies towards an often quoted “double-dip recession”?
I don’t think so, largely because of the following reasons:
·Asia’s banking system is resilient after the 1997/98 Asian fiinancial crisis revamp and remained strong, during and after the 2008 global financial crisis.
·Asian governments are acting very fast in curbing property bubbles, not allowing them to get too big; in particular Asian governments believe in market intervention as compared with Western preference to let free market forces decide.
·Asian bank housing mortgages are “recourse financing” (meaning one is liable for all losses even if the property is auctioned) as compared with “non-recourse financing” in the US (meaning after the property is foreclosed by the bank, one is no longer liable for further losses), therefore Asia’s borrowers are more committed.
·It is a cultural norm and quite common in Asia for an extended family to chip in during times of difficulties to help mortgage repayment.
·Asia’s property developers are also more careful in managing risks after experiencing the 1997/98 Asian financial crisis; many, such as in Malaysia and Singapore, use joint ventures with land owners to mitigate some of the risks.

The writer is the founder and chief investment officer of Singular Asset Management Sdn Bhd.

Building the right investment habits

SUCCESSFUL INVESTORS’ INVESTING HABITS

The local market condition is very hard to predict since it is affected by both global and local factors. As an investor, it may not be possible to predict what is going to happen next, but there are certainly ways to learn from people who have succeeded in riding the waves of good and bad times throughout the years.

In the book ‘The Winning Investment Habits of Warren Buffett & George Soros’, Mark Tier listed out 23 winning habits, based on these two world’s richest and most successful investors. Summarized below, are four main key habits that may be adopted as the fundamentals to successful investing.

Successful Investors’ Habit #1:
Preserve your capital and minimise risk taking

Capital preservation is the foundation used by all successful investors and they do this through risk minimization. Most investors have the perception that, in order to make profits in the market, there is a need to take big risks and it is right to say that risk and return come hand in hand. However, in order to ensure long term success, you should not just simply take any risk, but calculated risk. This requires you to analyse the situation and acquire confidence that the chances of having favor on your side is high. With that in mind, you would only end up investing in what Buffett calls ‘high probability events’, where the risk of loss is at the lowest and you are almost certain to make money. Always remember Warren Buffett’s ‘Investing Rule No. 1: Never Lose Money, Investing Rule No. 2: Never Forget Rule No. 1’!

Warren Buffet Investing Rules: Rule #1: never loss money! Rule #2: never forget rule no. 1

Successful Investors’ Habit #2:
Do your homework before you invest

There are thousands of companies listed in our stock market. Which one should you invest in? Having Habit No.1 as the foundation, you will know that the safest companies to invest in should be companies or industries that you are most familiar with, as you can only make good judgment if you have in-depth knowledge and understanding of it. You will have to do your own homework and research through all available sources, such as company annual reports, industry reports or public announcements, to obtain the facts on the industry, the company of your interest and its competitors. This is necessary to ensure that you can draw good conclusions on the company’s performance and future prospects. Therefore, time and hard work are the two essential elements in turning yourself into an informed and knowledgeable investor. In practicing this, you will also need to be selective and focused on certain industries that you the have most interest and experience in.

Successful Investors’ Habit #3:
Have your own investment philosophy and system

An investment philosophy is a set of beliefs that you use as the foundation in developing your personal investment system for buying and selling investments. This ensures that you are fully aware of the reasons behind every investment decision you make. As a beginner in the investing world, you could probably start by following the investment philosophies and systems of some of the great investors that come closest to your heart. However, along the way, you should tailor your investment system to suit your personality, goal and unique circumstance so that you can practice this entire system with ease and without any doubts. If you have the discipline to practice your system religiously, you will not be easily influenced by the voices or rumours in the market and would not be tempted to simply follow the crowd. As such, the chances of you making the wrong decisions will be minimised.

Successful Investors’ Habit #4:

Be Patient!

There is a Spanish proverb that says “The secret of patience is doing something else in the meantime”. If you somehow managed to inculcate the above 3 habits, you should know exactly what you are looking for and as such, should be well equipped with the patience to wait for the right moment to buy or sell your stocks. Both Buffett and Soros stressed the fact that the secret of their success is having the patience to wait. Use the free time to explore and strategise other new opportunities as there are so many companies listed in the market. Always remember that identifying the right candidates does require time and patience.

On the last note, try to adopt the above habits now! Remember, good strategies will only be successful with the right mindset in execution!

How to screen overseas stocks

Personal Investing - By ooi Kok Hwa

Four criteria to look at when choosing counters that are suitable for long-term investment

LATELY, interest has grown in overseas stock investment. Given the foreign markets’ relatively high volatility of returns compared with the local market, a lot of retail investors find it more exciting to invest in overseas stocks.

However, a common problem most investors face is how to filter, from among all the listed companies in the respective markets, the right stocks that are suitable for long-term investment.

Market capitalisation

One of the most important selection criteria is buying stocks with big market capitalisation. The market cap of a listed company can be computed by multiplying the number of its outstanding shares with the current share price.

In general, we should buy stocks with big market cap because they are normally well-established blue-chip stocks with higher turnover and widely-accepted products and services.

Even though some academic research shows that buying into small market cap stocks can provide higher returns compared with big market cap companies, unless we are quite familiar with the stocks available in those overseas markets, it is safer to put our money into bigger market cap stocks.

It is not difficult to find out which companies have the largest market cap in any stock exchange.

Such information is available in most major newspapers in that particular country or the stock exchanges themselves.

For example, if we intend to buy some Singapore stocks, we should pay attention to companies that are ranked in the top 30 in terms of market cap. One can get the rankings by market cap for the Singapore Exchange in StarBiz monthly.

Price/earnings ratio

Once we have filtered out the blue-chip stocks, the next selection criteria is the price/earnings ratio (PER), which should be lower than the overall market PER. This is computed by dividing the current stock price by the earnings per share (EPS) of the company. It represents the number of years that we need to get back our money, assuming the company maintains identical earnings throughout the period.

Even though some published PER may use historical audited EPS compared with forecast EPS, given that our key objective is to do stock screening, the PER testing will provide us with a quick check on the top 30 companies – whether they are profitable and selling at reasonable PER compared with the overall market PER.

If we cannot get access to the overall market PER, we may want to consider Benjamin Graham’s suggestion of buying stocks with PER of lower than 15 times.

Dividend yield

A good company should pay dividends. We strongly believe that this is one of the most important ways for the investors to get any returns from the companies that they invest in.

Our rule of thumb is that a good company should have a dividend yield that at least equals or is higher than the risk-free return, which is usually based on the fixed deposit rates.

The dividend yield is computed by dividing the dividend per share by the current share price. In general, most blue-chip stocks do have a fixed dividend payout policy and reward investors with a consistent and growing dividend returns.

Based on our observation, most smaller companies may not be able to pay good dividends as they may need the capital for future expansion programmes.

Price-to-book ratio

Most investors would like to invest at a market price lower than the owners’ costs in the company. The book value of a company represents the owners’ costs invested in it.

In a normal business environment, unless the company has some problems that the general public may not be aware of, it is quite difficult to find stocks selling at a price lower than the book value of the company.

As a result, we may need to purchase at a market price higher than the book value. According to Graham, the maximum price one should pay for any stock is the price which gives a price-to-book ratio no greater than 1.5 times. This means that we should not pay more than 1.5 times the owners’ costs invested in the company.

Lastly, the above four selection criteria are merely a preliminary quick stock screening process. Even though investors may be able to find stocks that fit the criteria, we suggest investors check further the fundamentals of the company, such as the balance sheet strength, its gearing, future business prospects and the quality of the management before deciding to invest.

● Ooi Kok Hwa is an investment adviser and managing partner of MRR Consulting.

What Is Your Investment Time Horizon?

Do you know whether you are a short-, medium- or long-term investor? What are the common definitions for these three time horizons? Generally, investment time horizon refers to the length of time for which an investment will be held before it is sold off in exchange for cash (liquidated). Time horizons can range from minutes, in the case of a day trader, all the way up to decades for a buy-and-hold investor. What is the right investment time horizon? Actually, there is no "right" or "wrong" time frame for investment - it all depends on the investor's investment objectives and goals, and his level of risk tolerance, i.e. how much risk he is willing to take.

Since every investor can define his/her investment time horizon in various ways, let us look at the most common definitions of short, medium and long investment time horizons.

Time horizons
Usually, as a general rule of thumb, investment horizons can be classified as-

• short term - one to three years
• medium term - three to five years
• long term - more than five years

Why you need to know them?
Knowing your time horizon is extremely important because it will help you in your investment planning, such as choosing the suitable investment products, monitoring their performance and most importantly, managing investment risks. All things being equal, you can afford to be more aggressive if you have a long-term investment horizon. For example, a 25-year old who is just starting a career will be able to invest in more volatile or risky investment products, since he will have a longer time frame to make the necessary adjustments should the investment suffer losses. But someone, who is close to retirement, should usually be more conservative and take the less risky route, as he does not have much time to make adjustments if his investment is not performing as expected.

However, age alone should not be the only factor in determining your time horizon. Factors namely risk tolerance, investment objectives, expected return, as well as when you will need the funds or money should also be taken into consideration. For example, a 30-year old is saving money for a house down payment and he plans to buy a house in a year's time. Given the short time frame, it will be prudent for him to invest more conservatively because he has little time to make up for any possible losses. Due to his short-term goal, he cannot afford to invest in risky products even though he still has a long way to go before retirement.

As an intelligent investor, it is crucial that you consider and determine your investment time horizon before investing. But do not cast it in stone, as it needs to be flexible to cope with situations where your investment does not perform according to your expectations. In such situations, you must always be ready to change your investment time horizon and set it to your advantage.

Structured products fast gaining investors' attention

Published: 2009/07/08

As an investor, structured products can certainly help enhance the returns of your investment portfolio. This, however, requires you to do your homework, says SIDC

THE environment nowadays is fast changing, making investors pursue greater benefits from a product that can give them higher returns.

Today, investors are equipped with the ability to stay alert to any movement in the market. This stems from easy access they have to information needed in making investment decisions, and this is what keeps them ahead in securing profit gains and minimising losses.

As investors become more sophisticated, they are more informed of various investment options, the basic asset classes of cash, equities and bonds are no longer sufficient to fulfil their needs and return expectations.

In meeting the expectations, financial institutions come up with various new products that offer high returns.

If you have been monitoring the banks over the past five to 10 years, you will notice the changes in the products they offer. These products have evolved from just simple fixed deposits to various alternative financial products, and one of the latest offerings that is fast getting the attention of the public is structured products.

What are structured products?

Under the Securities Commission's Guidelines on the Offering of Structured Products, "structured product" means any investment product that falls within the definition of "securities" under the Securities Commission Act 1993 (SCA) and derives its value by reference to the price or value of an underlying reference.
"Underlying reference" means any security, index, currency, commodity or other assets or reference, or combination of such assets or reference.

In simpler words, structured products are basically alternative financial instruments or securities, the performance of which is linked to underlying assets such as security, index, currency, commodity or other assets or a combination of several underlying assets. Structured products are usually classified according to the underlying assets that it is being indexed to.

Below are some examples of structured products that you can find in the Guidelines on the Offering of Structured Products:

* Equity Linked Notes

* Bond Linked Notes

* Index Linked Notes

* Currency Linked Notes

* Interest Rate Linked Notes

* Commodity (Contracts) Linked Notes

* Credit Linked Notes

With the regulatory liberalisation in Malaysia, structured products that were once only available to institutional investors and high net-worth individuals are now accessible to the mass market through structured investment, such as Floating Rate Negotiable Instruments of Deposits (FRNID), which have a minimum investment amount of RM100,000 (under the guidelines of FRNID by Bank Negara Malaysia), structured unit trust funds, which have been allowed to invest in structured products only since May 2006, and capital-protected, investment-linked insurance that invest in FRNIDs or structured products.

Structured products usually have a fixed maturity, with two components, a note and a derivative. While a note provides for periodic interest payments to the investor at a predetermined rate, a derivative component provides for the payment at maturity.

A key feature of most structured products is a "principal guarantee" function which offers protection of principal, if it is held to maturity.

For example, if you invest RM100, 80 per cent of it might be used to purchase a risk-free fixed- income securities or money market instruments, which will give RM100 in five years. The remaining 20 per cent will be invested in a financial derivative, which will provide the additional benefit that is being targeted in the investment strategy.

One of the most prominent benefits of structured products is the flexibility to provide tailor-made products according to investors' risk and return profiles. As the products are not standardised, they can be customised to meet an investor's objective of enhancing return with limited downside risk in rising or falling markets, using capital guaranteed structured products.

For the more aggressive investors, they can choose to invest in non-capital guaranteed products which have higher return potential at higher risk and without downside protection at maturity.

As the performance of the embedded derivative of a structured product is linked to its underlying asset, the biggest risk factor in investing in it is the change in the asset value. Such change can be quite volatile and complicated as some structured products are based on a combination of a basket of underlying assets.

Even if some of the products offer 100 per cent capital guarantee, you still have to deal with the risk of potentially losing all of your money if the issuer defaults. Here, the recent Lehman's debacle makes for a good example.

In addition to this, due to its fixed maturity, you may lose part of your capital, depending on the market situation as it will be marked-to-market.

As an investor, structured products can certainly help enhance the returns of your investment portfolio. This, however, requires you to do your homework.

As with any other form of investment, it is crucial that you fully understand the various types of structured products before investing in them.

Structured products can be rather complex, as such, make sure you know them well so as to manage your risk; give careful thought to the risk inherent in this type of products versus your own risk profile. This is especially important if you are currently a retiree or depending on your savings for some urgent needs.

Remember, "Every choice you make has an end result" - Zig Ziglar. So, make your choice wisely, not blindly!

This article was written by Securities Industry Development Corporation (SIDC) to educate investors on smart investing. The information provided is for educational purposes only and should not be used as a substitute for legal or other professional advice.

SIDC - the leading capital markets education, training and information resource provider in Asean - is the training and development arm of the Securities Commission. It was established in 1994 and incorporated in 2007.

For more tips on wise investing, log on to www.min.com.my

Diversified portfolio cuts risks

Published: 2009/07/06

This article explains how a portfolio of exchange traded funds and unit trust funds can lower overall risks. THERE is a saying among the investing community that the only free lunch is portfolio diversification. The diversification concept is centered on different asset classes, each with a unique risk and return profile, thus reacting differently during an economic cycle. But even if reducing risk of a portfolio is 'free', it is hard to achieve without foolproof rules to follow.

The portfolio strategy of each investor depends largely on factors such as age, financial goals, life expectancy, risk tolerance and time horizon. These criteria would determine the exact asset allocation of different asset classes.

Generally, most investors would hold a combination of equities, fixed income and cash in their portfolios while the savvier ones may include property via real estate investment trusts and commodities. Regardless of the number of different asset classes, reducing the overall risk of a portfolio still requires diversification within an asset class, for example, by holding various industries to represent equity. This can be easily and cheaply done with exchange-traded funds (ETFs) and unit-trust funds.

ETFs and funds are investment vehicles that hold a basket of individual securities. This allows an individual investor to take a position in many individual companies or fixed income securities with one trade. It cost much less to buy units in an ETF or unit trust fund as compared to buying individual securities.

Although diversification is offered by ETF and funds, they are structurally different investing vehicles (refer to box). A key differentiator between ETFs and funds is the investing approach. Unit trust funds are actively managed by fund managers which attempt to outperform the market by identifying and buying selected securities.

Some fund managers also time the market in order to ride the upswings and avoid the downturns. In contrast, ETFs are passively managed investment vehicles that aim to track a broad market by mirroring an index. Index-based funds have the same objective as index-based ETFs but are structured and behave like actively managed funds.

Investors can utilise both ETFs and funds to lower the overall risk of an investment portfolio. A well-designed portfolio uses ETFs and funds that complement each other. For example, the main or core holdings of a portfolio, usually made up of the broad market of domestic stocks or fixed income securities, can be represented by ETFs such as FTSE Bursa Malaysia KLCI etf, MyETF-DJIM25 or ABFMY1. These ETFs trade on Bursa Malaysia and give exposure to the 30 largest listed companies in the country, the 25 biggest Syariah-compliant listed companies and a basket of government bonds respectively.

Meanwhile, actively managed unit trust funds can be used for tactical investments that require a fund manager's stock picking skills. For example, investors that believe that extra returns can be made with growth, undervalued or small-cap stocks can opt for funds with a growth or value investment mandate or a small-cap fund. These funds will complement a broad market-based ETF since both are unlikely to hold shares in the same companies.

Investors that are keen on adding foreign exposure to their portfolio, can opt for market or region specific unit trust or ETFs that invest solely in China or in developed countries. ETFs on the local stock market are currently limited to local securities, however, revisions to the guidelines in June paves the way for cross-listing of foreign ETFs on Bursa Malaysia.

Although a portfolio is diversified, it can still lose value during times of extreme market stress. In such conditions, equity markets around the world tend to behave poorly over the short-term as experienced during last year's global financial crisis. This abnormal behaviour eventually tapers out and negatively correlated markets return to moving in opposite directions. This lends credence to a long-term investing approach as investors with a long-time horizon can better tolerate short-term volatility.

Investors holding actively managed funds must monitor and evaluate performance over several years as it may take some time for a fund to perform. Consider replacing funds that consistently underperforms its benchmark and its peers in the same category. ETFs require less analysis although investors should occasionally check that its performance closely replicates the underlying benchmark.

What is the impact of depression on your investment

Gock's Viewpoint - A column by Choong Khuat Hock

Is the world heading for L-shape stagnation?

THE world is heading for an L-shape stagnation due to a long deleveraging process after an orgy of excesses that led to a debt and housing bubble.

The total US debt (private sector and government debt) as a percentage of GDP at 358% at Sept 30, 2008 is highest ever in US history, higher than even during the Great Depression.

The ratio has since risen further to 375% at March 31, 2009 as the US GDP shrank while total debt rose due to government borrowing.

Easy and irresponsible financing fuelled a 130.6% rise in house prices from 1997 till 2006. Highly-leveraged US consumers are worried about rising unemployment and have lost US$13 trillion in the value of household assets between mid-2007 and end-2008 as a result of falling house and stock prices.

Deleveraging by consumers could take over a decade, after all, Japan has yet to fully recover from the bursting of its debt-fuelled property bubble in 1990 despite low interest rates and aggressive pump priming which saw government debt to GDP rising from 60% in 1990 to 162% in 2008.

Why should we be worried about what is happening in faraway United States?

The reason is because the country is the largest importer in the world.

US consumer spending accounts for 70% of the US economy and, as long as US consumers are deleveraging (spending less and saving more), it is unlikely for Asian exports to rebound sharply. For example, gross Malaysian exports peaked at RM63.3bil in July 2008 and had declined to RM41.1bil in April 2009, down 26.3% from a year ago.

In the region, Singapore – which is most dependent on trade with an average annual trade to GDP ratio of 444% between 2005 and 2007 (compared with a ratio of 209% for Malaysia) is the worst affected while those with a large domestic economy, which is less dependent on trade like Indonesia (trade to GDP ratio of 60%), are still growing. In the first quarter this year, Singapore’s GDP fell 10.1% from a year ago,

Malaysia fell 6.2% while Indonesia grew 4.4%. China, with a high savings rate and the ability to undertake aggressive fiscal pump priming due to low government debt levels, is also showing signs of recovery.

However, China only accounted for 6.8% of the world economy in 2008 and cannot completely offset the decline of large economies like the United States, European Union and Japan, which in total account for 61.1% of the world economy.

The book D is for Depression talks about the implications of a prolonged period of L-shape stagnation for investments.

If the Federal Reserve and central governments do not print money, interest rates are likely to remain low for decades. In this scenario, accumulating assets with sustainable yields become paramount.

After the Great Depression, interest rates did not surpass levels in 1920s until 1968. In Japan, interest rates have not recovered to the pre-1990 levels despite modest printing of money.

The United States, unlike Japan, does not have large domestic savings to rely on when the bubble burst. Neither can the United States rely on boosting exports to compensate for falling private sector demand. It has been relying on countries like China and Japan to purchase its debt. However, these countries have become increasingly wary of US debt with rising US government debt levels and a weakening US dollar.

If printing money becomes the preferred tool to fight deflation and to deflate away debt held by the United States and devalue the real value of bonds (held by foreigners), the book discusses implications for investments in an inflationary world.

● The writer is the author of the book titled “D is for Depression” which is available in Malaysian book shops this week. He further elaborates on the L-shape stagnation theory in his book.

What is an earnings surprise?

Personal Investment - A column by Ooi Kok Hwa

Clearing the air on market rallies amidst disappointing results

RECENTLY, our stock market was experiencing a rally, which caught a lot of investors by surprise.

As we are now in the reporting season for the companies’ first-quarter financial results, those results that are available thus far show that most companies’ financial performances have indeed slowed down due to the global economic downturn.

Looking at the seemingly contradicting response from the market, how do we relate and explain for the market rally in the midst of the disappointing results from the companies?

If you read the comments from the analysts, you will notice that more often than not, “earnings surprise” is the main reason for the stock prices to increase even though the companies’ result may be down from the previous quarter.

What is an earnings surprise?

An earnings surprise happens when the actual earnings from a company are significantly above or below the market expectation.

Therefore, before an earnings surprise can exist, there must be an earnings expectation from the market. The earnings expectation may be derived from either a simple extrapolation from the historical trend or based on analysts’ forecasts and consensus.

When the earnings expectation for a company is based on historical results, it means that the market is expecting the established income or profit trend for the company or industry in the past to continue into the future.

Therefore, if the actual results happen to deviate significantly from the past trend, it is often being referred to as an earnings reversal or a turning point and, when this happen, it will be called an earnings surprise.

Alternatively, an earnings expectation can be based on consensus from analysts’ forecasts.

Individual analysts will usually use the prior year’s results as a starting point, incorporating any potential impact due to macro-economic or firm-specific factors that they can foresee into the forecasts, to arrive at a more realistic projection of the future.

The market will then gather the forecasts from various analysts, who may be of different views and form a consensus, that smoothen out the impact of divergent views.

When the actual earnings come out to be different from the average forecasts or the consensus, the difference between this two will be the earnings surprise.

Compare with the earlier method, which is a more simplistic method, the earnings expectation based on market consensus is more meaningful as it has included most foreseeable events.

However, this does not mean that the expectations based on analysts’ forecasts are always right.

When there is error in the forecast, and the difference between actual earnings and expected earnings is mainly due to the forecast error, it will not be a surprise to the market and therefore the market will not react to it.

Causes of earnings surprises

An earnings surprise is usually caused by an event that is firm-specific, industry-specific or by an unexpected change in the economic fundamental factor.

Examples of causes include excessive inventory build-ups in inventories and account receivables, emergence of new competitors or competitive products or services in the industry, failure to introduce a new product or services that is much awaited by the market, unexpected changes in the accounting policies or accounting estimates and so forth.

As there are countless possibilities to the causes of earnings surprises, while the analysts may try their very best to use their crystal balls to predict the future, we all know that predicting the future is no easy task.

Thus, more importantly, we need to know how to identify early warning signs or indicators to avoid the surprises.

Market rally versus company performance

Coming back to our initial question, how do we explain the market rally when the companies’ performances are in the red?

As the stock market has already reflected all the good and bad news in the market prior to the companies’ announcements, therefore, even if the results of a particular company are worse off compare with previously, as long as the actual results are consistent with the market expectation, the stock price will not react to the announcement.

If in the event that the actual results come out to be better than expected, even though it is still in the red, it is considered as an earnings surprise and the market will react positively to the announcement.

In our recent market rally, we can see that the results posted by many companies are not as bad as earlier expected, resulting in their stock prices going up.

Of course there are also other external factors, such as expectations that the global financial crisis is coming to an end and the economy is on its way up, are helping to boost the stock market performance.

Ooi Kok Hwa is an investment adviser and managing partner of MRR Consulting

Unit trust fund prospectus: What you need to know

Published: 2009/05/06

Almost everyone everywhere may have heard this message "Please read the prospectus before investing". Be it from the radio or by any pamphlets/leaflets in relation to unit trust investing.

The question is - do you know how to read one?

What is a prospectus?

A prospectus is the most important document that you need to get hold of before committing yourself to a fund. It serves as a roadmap for you to know what you can expect to get from the fund.

Since there is a wide range of unit trust funds being offered in the market with various investment objectives and risks involved, investors need to make wise decisions in choosing suitable funds for themselves. As with any other form of investment, investors need to do their homework first before jumping on the bandwagon. This among others, entails reading unit trust funds' prospectuses.

Guide to reading a prospectus

Before you make that final call to part with your money, get yourself a copy of prospectuses from different funds and read through them to get a better understanding of the different funds available.

Here are some of the key elements that you need to remember when reading a prospectus:

* Investment objective

* Investment objectiveWhile some funds are aimed at providing a steady stream of income, others are mainly focused on gaining long-term capital growth, or a mix between the two. Depending on your own investment objective, when you choose a unit trust fund, make sure that the investment objective of the fund is consistent with what you intend to achieve with your money.

* Investment strategy

* Investment strategyThis tells you how the fund managers are going to achieve the stated objective; the approach that they are going to take and how the asset allocation is going to be in terms of exposure to various investment vehicles and sector selections. It also highlights the relevant domestic or foreign exposures of the fund. You may want to check on the fund's turnover rate, as to how frequent the managers re-balance the portfolio through buying and selling. High frequency of trading may indicate high transaction cost, which will eventually eat into the profit of the fund.

* Risk factors

* Risk factorsPay attention to the risk factors stated and compare them to your own risk profile and risk tolerance level. The risk factors faced are typically market risk, interest risk, liquidity risk and credit risk. A fund holding investments in emerging markets will be subjected to the economic and political conditions there. Any changes in the foreign currency exchange rate will affect the return of the respective funds.

* Investors' profile

* Investors' profileMost prospectuses include an investor profile as guidance for potential investors. It tells you the characteristics of investors who will potentially invest in the fund. However, this is subject to your own unique circumstances that you will need to observe.

* Financial performance

* Financial performanceThis serves as a good indicator of how the fund is managed, especially if the fund has been in existence for a long period. If the fund has managed to survive through adverse conditions, you will naturally have more confidence in its future performance. You can also use this to compare a particular fund's performance with that of other similar funds and its performance benchmark.

Remember! Past performance does not guarantee future success of the fund!

* Fees and charges

* Fees and charges As all unit trust funds are professionally managed, various expenses and charges will be incurred, compared to an outright purchase of a security. Some of the relevant fees and charges are:

1) Load (sales commission)

Load funds can charge a front-end load (when you purchase fund shares) or a back-end load (when you sell your shares).

2) Redemption fee

While loads are calculated on the amount you invest, redemption fees are calculated as a percentage of the value of your account when you get out.

3) Purchase fee

You may be charged for share purchases. While a front-end load is paid to a broker, purchase fees are paid to the fund for some of the fund's costs associated with the purchase.

4) Exchange fee

This is incurred for exchange (transfer) to another fund within the same fund family.

5) Management fees

This is paid out of the fund's assets and covers operating expenses of the fund's managers and advisors.

6) Distribution fees

This covers fees paid for distribution of fund literature, marketing costs, and sales commissions paid to brokers.

7) Administrative fees

Included here are expenses such as custodial expenses, legal expenses, accounting expenses, and transfer agent expenses.

All the above charges will be added up when calculating a fund's expense ratio, which is expressed as a percentage of the fund's assets. It will enable you to make a meaningful comparison among the cost structure of different funds.

Last words

Prospectuses may not be as attention grabbing or engaging as your hot selling novels, but reading them is a must! Spending some of your precious time going through them is definitely worthwhile! It helps to prevent you from making investment decisions that you will end up regretting later. Confucius once said, "Good people strengthen themselves ceaselessly" and we believe that good investors strengthen themselves with constant pursuit of knowledge endlessly.

Securities Industry Development Corporation (SIDC), the leading capital markets education, training and information resource provider in Asean, is the training and development arm of the Securities Commission, Malaysia. It was established in 1994 and incorporated in 2007.

When investing in stocks control your greed and fear

Personal Investing - A column by Ooi Kok Hwa

We need to know who we are in order to do well in stock market investing

THE recent strong market rally caught many investors by surprise again.

Most investors, including some analysts, predicted earlier that it was just a bear market rally. They have been hoping the market will turn down again. Unfortunately, it has been moving up strong without looking back.

For investors who have not invested during the recent low in March 2009, they are getting very worried as they are not benefitting from the recent rally. They may even wonder whether they should jump in now in order not to miss the boat.

Another group of investors, who have managed to catch some stocks at cheap prices during the previous market low, are also facing the dilemma of whether to lock in their gains now or continue to hold on to their gains. Some even regretted selling their stocks too early last month.

We all know that it is very difficult, in fact impossible, to predict stock market movement. Most investment gurus will refuse to time the market.

Howard Kahn and Cary Cooper published a book titled “Stress in the Dealing Room” in 1993. According to their surveys done on 225 dealers, 73.8% of them suffered from fear of “misreading the market.” Most dealers have the same problem of acquiring and handling information.

We believe that in order to do well in stock investing, we need to know ourselves, especially in controlling our emotion on greed and fear.

Due to information overloading, our emotion is highly influenced by the news that we read. Each time we feel that the market is getting bullish and time to buy stock, the overall market will collapse the moment we enter.

On the other hand, the moment we fear that it will drop further and we have decided to cut losses, we will notice the market will recover after that. Most of the time, the prices of stocks that we sold were at the lowest of the recent fall.

In order to control our greed and fear, we need to ask ourselves whether the market has discounted the news that we have received.

For example, many analysts have been bullish lately, having the opinion that the worst may be over for the market based on the recent economic indicators which showed that the overall economy may have stopped contracting or is on its way to recovery.

Nevertheless, the recent strong market rally would have discounted this bullish news. In fact, we need to ask ourselves whether the current stock prices can be supported by the fundamentals for certain listed companies.

In our experience, in most cases, the moment we feel like buying stocks is the best time to sell them while the moment that we feel like selling them is in fact the best time to buy. We can apply this contrarian theory quite successfully in most periods.

Sometimes, if we are taking in too much contradicting information and, as a result, get confused over the market direction, we feel that the best strategy is to stay away from the market until we have a better and clearer picture of the overall market or the economic situation.

We should not be influenced by other opinions.

There are times that we need to follow our heart. Sometimes, our hearts try to warn us from taking hasty investment decisions. However, we refuse to follow our intuition but instead, choosing to get influenced by others or the information that we read and ending up making mistakes.

In conclusion, we need to maintain our concentration.

We should not be led by the market sentiments regardless whether it is on the way up or crashing down fast. We need to go back to the fundamental of economic situation and the companies’ performance and future prospects.

One way to minimise the feeling of regret is to stagger our purchase and selling. We will only know the peak when the market starts turning downwards and vice versa. Therefore, by staggering, we will have an averaging effect rather than taking a one-time hit, especially if it is at the wrong timing.

Ooi Kok Hwa is an investment adviser and managing partner of MRR Consulting

Behaviour and projections

This article intends to explore the behavioural side of those who make stock market projections

THE economic tsunami that has hit the world since late-2007 has left many wondering where it is heading, what to expect, etc. Experts as well as laymen make projections, mostly trying to predict when the stock market will hit bottom. Unfortunately, no one can really provide a definite answer. Setting aside the technical details of the various projections that have been and are being made as we speak, this piece intends to explore the behavioural side of those who make these projections.

Gambler Fallacy

According to Hersh Shefrin, in his book titled "Beyond Greed and Fear", research has shown that strategists and analysts are often caught in a behavioural phenomenon called "gambler fallacy"- the misconception that the law of averages can be applied to even a small sample size.

This is illustrated by a simple coin-tossing game. If five consecutive tosses of a coin come up heads, most people tend to think that the sixth toss should be tails, even though the probability of getting either heads or tails is 50/50. Going by this, some predictions tend to project inappropriate trend reversal as evident by a study done by De Bondt in 1991. Based on published predictions by Wall Street analysts, the study shows that the analysts are overly pessimistic after three-year bull markets and overly optimistic after three-year bear markets.

What does this behaviour mean to you?

It is especially important if you use the projections to make investment decisions. When dealing with a bear market that has yet to touch the bottom, using an overly optimistic projection would lead to the wrong decision. You stand to lose by buying certain stocks believing that their prices are low enough and the downtrend is going to reverse anytime soon, only to find that the prices continue to drop. By the time the market actually hits bottom, you may have already used up your resources.

Naive Extrapolation

Studies have shown that individual investors have the behaviour that is quite the opposite of what has been described above. The retailers in the market, for instance, have the tendency of doing simple extrapolation - projecting the future based on the recent past. As a result, they are overly optimistic during bull markets and overly pessimistic during bear markets.

Seasoned investors would always tell you to prepare to leave the market when you hear that people around you (especially those who've hardly ever talked about investing) start to be active in the stock market. This may indicate that the bull run is about to end. Unfortunately, new and inexperienced investors would naively think that the bull run would continue.

The time to look around hard is when no one is talking about buying stocks. Your golden opportunity in getting good stocks at a bargain surfaces when others steer clear of buying them. As Warren Buffett said, "Most people get interested in stocks when everyone else is. The time to get interested is when no one else is. You can't buy what is popular and do well".

Overconfidence

Both the analysts and individual investors have something in common. They are overconfident when it comes to predicting the future. So, they often end up getting surprises. Interestingly, it has also been found that experience plays an important part here. Those who are inexperienced turn out to be the ones that have greater confidence in their predictions and therefore higher expectations in stock market returns. Seasoned investors and analysts, on the other hand, tread with more caution and are more conservative in their investment approach.

Less Predicting, More Reading!

The combined effect of the behavioural phenomena from the investors drives market sentiment. As an intelligent investor, learn to separate yourself from the herd effect and try not to fall into the biased behaviour described above. You need to be aware of the market direction, but don't waste too much time predicting when the market will bottom out. Instead, spend your valuable time reading more and doing your research on the companies of your interest. Understand the fundamentals well and learn from errors that others have made in the market.

Securities Industry Development Corporation, the leading capital markets education, training and information resource provider in Asean, is the training and development arm of the Securities Commission Malaysia. It was es tablished in 1994 and incorporated in 2007.

The ABC of warrants

Published: 2009/04/22

One possible reason warrants take a back seat to stocks is the lack of understanding among investors. However, they can be a good alternative investment vehicle to consider.

INVESTORS, Malaysian investors typically, often delve into the know-how of stock investing and unit trust. However, relatively little is said about warrants. One of the many possible reasons that warrants take a back seat to stocks is the lack of understanding among investors.

You may have been told that investing in warrants is risky; that they are more volatile compared to stocks.

However, if you spend some time to learn about them, you will discover that warrants are in fact a good alternative investment vehicle for you to consider. You can make it a part of your investment portfolio and allow yourself room for diversity if you understand it well enough.

An article called "The ABC of Warrants" may seem elementary to some, but it always pays to get your foundation right!

* What is a warrant or call warrant?

A warrant or call warrant basically gives the holder the right, but not the obligation to purchase a specific number of the mother or underlying shares at a specific price within a specific period. They are often included in a new debt issue as a "sweetener" to entice investors.

The holder of a warrant or call warrant will not have any voting or dividend rights as that enjoyed by shareholders. As such you need to be mindful of the fact that as a holder of warrants or call warrants, you will not be entitled to have a say in the company's management decisions.

* Warrant vs call warrants

The typical difference between a warrant and a call warrant is that a warrant is issued by a company for the purpose of raising capital for that company.

Warrants are usually tagged with a longer maturity, usually more than 4 years stretching up to 10 years.

A call warrant on the other hand is issued by third party financial institutions on shares of an unrelated company or shares of a basket of companies. Call warrants usually come with a much shorter maturity period of less than one year.

* American or European?

Warrants or call warrants can also be subdivided into two categories based on their exercise style - either American or European. An American warrant can be exercised at any time up to its maturity date while a European warrant can only be exercised at its maturity date.

What happens when an investor exercises his rights for a company's warrant is that the company will issue new shares to meet the obligations which will result in share dilution. As for a call warrant, the issuer will meet its obligation using outstanding shares. Hence, no new shares will be issued under the call warrant. If the warrants or call warrants are not exercised on expiration, they will turn worthless.

* Value of warrants and call warrants

The value of a warrant is determined by two main factors, its intrinsic value and time value. Its intrinsic value is the difference between the current price of the underlying asset and the warrant's exercise price.

A warrant has a limited life span and as such, when you are looking at the time value, as time passes the value will decrease accordingly until it turns zero on expiration. The factors that will positively affect a warrant's time value are the expected volatility of the underlying stock and the warrant's time to maturity.

* Why invest in warrants?

The main benefit of investing in a warrant is cost leveraging. When you invest in a warrant, you stand to gain from the exposure of the share price movement at only a fraction of its cost. In terms of percentage, a warrant is more sensitive to the market movement compared to its underlying assets.

Therefore, by investing in a warrant, it allows you to benefit from unlimited upside at a lower cost. Apart from that, you can free up your capital to invest in other investments. The downside risk of not being able to exercise the warrant is only the loss of the warrant premium.

* What should you do?

If you want to invest in warrants, you should first understand how the product works and the risks associated with them. The performance of a warrant is closely linked to the price movement of its underlying assets. As such, if you are expecting an uptrend market and have strong confidence in the underlying shares, then the chances of you reaping rewards from investing in warrants is very high.

However, if the market is experiencing a downward trend and the time to maturity of your warrants is limited, then you should be more cautious in buying them. This is particularly crucial if the current market price of the underlying share is lower than the exercise price of the warrant.

A more disciplined way of investing in warrants is to set a time limit for the underlying share to reach your targeted price. If the price does not measure up to your expectations by then, you will need to re-evaluate your position according to your risk/return profile.

In instances where the stock market has been bearish and you have no idea whether the market trend is going to reverse anytime soon, then, you may want to go for warrants with a longer time to maturity. A warrant based on an underlying stock that is in good financial health with good business prospect and has at least 3 years to maturity can be an option for you.

Securities Industry Development Corporation (SIDC), the leading capital markets education, training and information resource provider in Asean, is the training and development arm of the Securities Commission, Malaysia. It was established in 1994 and incorporated in 2007.

What causes stock prices to move?

Knowing the answer to this will enable you to buy and sell at the right time.

STOCK investing is perhaps the most talked about form of investing. Stocks create hype because they are volatile and sensitive to various factors. With the current economic landscape and dismal performance of bourses worldwide, we can observe that stock prices are affected on a much larger scale than usual. So, if you are wondering what makes stock prices go up or down, read on to find out.

Knowing the answer to this will enable you to buy and sell at the right time. Unfortunately, there is no one definite answer to this simple question. Various factors influence stock price movements. However, certain primary factors have a major impact on the movement and as an investor, you need to pay attention to these factors as guidance in making the right call to "buy" or "sell".

Demand and Supply

This golden rule of economics holds true even when it comes to the stock market. When demand for stocks is greater than supply, stock prices will go up. This happens when everyone starts to chase after stocks but only very few are willing to sell. This in turn, pushes the prices of stocks up further. On the flip side, when supply is greater than demand, everyone rushes to sell off their stocks, but only a few buyers are interested. This results in stock prices being depressed.

Bearing this in mind, you then need to know what causes the demand or supply to go up or down.

* Economic situation

* Economic situation Stock market performance is actually a leading indicator of our economic situation. This means that the stock market will reflect the market expectations of our economy a few months down the line. As such, if the market expects the economy to boom, you will start to see stock prices increasing much earlier than the actual boom and the opposite applies when recession hits. Bearing this in mind, as investors, you need to be sensitive to signs that provide any form of indication on the future direction of the economy.

For example, when inflation rate creeps up; there is a possibility that the interest rate will go up as well to help cool the economy. The stock market in turn, will react negatively given such an expectation. On the other hand, when the economy is at the bottom of its cycle and the interest rate is lowered to stimulate economic activity, you will see that stock market will react positively to it. This positive reaction is attributed to the expectation that the economy is on the road to recovery.

* Company performance

* Company performanceLogically, the stock price of a company should go up if its financial performance is good, and vice versa. However, you will notice that most of the time, when the financial results are announced, as long as they reflect analysts' expectations, regardless of whether the reports bear good or bad news, stock prices will usually not show much movement. It is only when the results come as a surprise to the market that you will see a blip in the price. Basically, this is because the existing stock prices already reflect the current market expectation. This tells you that you need to pay attention to the company's business fundamentals, as this is the critical factor that is going to influence the company's stock price in the long run. As an investor, you should be mindful of the company's business direction and projects that it is involved in, that have the potential of bringing growth to the business. You have keep a watchful eye on its financial performance and management's strength, in order to make a good investment decision.

* Market rumours

* Market rumoursThis is a major contributor to the stock market's short term volatility. There is a famous saying in the stock market, 'buy on rumours, sell on facts'. Investors tend to over-react or react hastily to the slightest market rumours. Often times, they will panic and rush to sell on negative rumours, resulting in the drop of the stock price. Investors could take the opportunity to buy at that particular time if they know that the company is fundamentally strong and the likelihood of the negative rumours being accurate is low; or the situation is not as bad as it is made out to be. By carefully scrutinising market rumours, you are able to make sound investment decisions instead of just following the crowd, that could lead to dire consequences.

* Political instability

* Political instabilityNaturally, if a country is experiencing political unrest, the stock market will inevitably have to deal with some setbacks. In cases of instability, foreign investors react by pulling out their funds which may trigger panic selling from all parties. You will need to assess whether the unrest is just a short-term event or carries with it a longer lasting impact. This is crucial in assessing your risk should you choose to continue holding on to your position, as opposed to taking quick action to leave the market.

The above are only a few major drivers that will cause the stock prices to move. However, most of the time, the investor psychology effect of over reacting makes market movement more prominent than it should be. One of Benjamin Graham's investing principles encourages us to look at market fluctuations as our friend rather than our enemy, as market movements sometime create buying opportunities for true investors. Therefore, as an informed and knowledgeable investor, avoid getting into "panic mode". Always remember, understand and evaluate the situation by using your own judgement to ensure that you make intelligent investment decisions.

This article was written by Securities Industry Development Corporation to educate investors on smart investing. The information provided in this article is for educational purposes only and should not be used as a substitute for legal or other professional advice.

Securities Industry Development Corporation, the leading capital markets education, training and information resource provider in Asean, is the training and development arm of the Securities Commission, Malaysia. It was established in 1994 and incorporated in 2007.

What’s the real rate of return?

Personal Investment - By Ooi Kok Hwa

THE recent reduction in interest rates by Bank Negara caught a lot of depositors by surprise.

Lately, some senior citizens who had been dependent on interest from fixed deposits (FD) for their living expenses have been complaining about the low returns from FD not being able to cover the high inflation rates.

Even though there have been signs that our inflation rate has been heading south from the peak of 8.5% in August 2008 to 3.9% in January, the current 12-month FD rate of about 2.5% is still lower than the latest inflation rate of 3.9%.

If we use the 12-month FD rate as our risk-free rate (instead of the common market practise of 10-year Malaysian Government Securities or MGS rate), the real rate of return to depositors is only minus 1.4% (2.5% - 3.9%).

This explains why some depositors have been quite worried that they may not be able to survive if they continue to depend solely on interest from FD to cover their living expenses.

Even though the Government has encouraged the public to spend money, a lot of people have been holding back their expenditure on some luxury items following the threat of unemployment. They only spend money on necessary items.

Besides, they will continue to place money in FD even though they are aware that the real rate of return is negative.

Based on Bank Negara’s monthly statistical bulletin of 30-year average 1-month, 12-month FD rate and the inflation rate (as measured by the Consumer Price Index or CPI), our real rate of return was positive at 2.9% if we compute it based on the average 12-month FD rate and inflation rate of 6.1% and 3.2% respectively (see table).

The table shows that in an expansionary economy or high interest rate environment, the real rate of return increased to between 6% and 7% during the years 1984, 1985, 1986 and 1997.

However, when our economy went into recession in 1988 and 1998, the real rate of return tumbled to 1.8% and 0.4% respectively.

Hence, even though the real rate of return was minus 1.7% last year – the first time over the past 30 years – we need to understand that the real rate of return will improve when the overall economy recovers.

Investors need to understand that it is not possible to generate the average real rate return of 2.9% every year.

During the current tough economic environment, we also need to understand that the primary concern is to protect capital.

Bank Negara has guaranteed that it will protect money placed in the banks until December 2010.

Hence, we need to make sure that we have enough reserves to help pull us through the current downturn.

According to the rule of thumb of financial planning, we need to have savings to cover four to six months of our living expenses.

We believe that as long as we continue to save money and spend less, it is acceptable to get negative real rate of return during this period.

● Ooi Kok Hwa is an investment adviser licensed by the Securities Commission and managing partner of MRR Consulting.

Key habits of successful investors

BUSINESS TIMES

Four key habits an investor might want to adopt are: Preserve capital and minimise risk taking; do homework before investing; have an investment philosophy and system; and, be patient.

IT IS a fact that the local market condition is very hard to predict since it is affected by both global and local factors. As an investor, it may not be possible to predict what is going to happen next, but there are certainly ways to learn from people who have succeeded in riding the waves of good and bad times throughout the years.

In the book "The Winning Investment Habits of Warren Buffett & George Soros", Mark Tier listed out 23 winning habits based on the habits of these two of the world's richest and most successful investors. Summarised below, are four main key habits that you might want to adopt as the fundamentals to successful investing.

Successful investor habit 1: Preserve your capital and minimise risk taking

All successful investors preserve their capital as a foundation and they do this through risk minimisation. Most investors have the perception that in order to make profits in the market, there is a need to take high risks and it is right to say that risk and return come hand in hand.

However, in order to ensure a long-term success, you should not just simply take any risks, but only calculated risks. This requires you to analyse the situation thoroughly as to be confident that the chances of having a good result on your side is high.

With that in mind, you would only end up investing in what Warren Buffett calls "high probability events", where the risk of loss is at the lowest and you are almost certain to make money. Always remember Warren Buffett's 'Investing Rules: "Rule No. 1: Never Lose Money! Rule No. 2: Never Forget Rule No. 1"

Successful investor habit 2: Do your homeworkbefore you invest

There are nearly one thousand companies listed in our stock market. Which one should you invest in? Having Habit No.1 as the foundation, you will know that the safest companies to invest in should be companies or industries that you are most familiar with, as you can only make good judgments if you have in-depth knowledge and understanding.

This means that you will have to do your own homework and research through all available sources, such as company annual reports, industry reports or public announcements, in order to obtain the facts on the industry, the company of your interest and its competitors.

This is necessary to ensure that you can draw good conclusions on the company's performance and future prospects. Therefore, time and hard work are the two essential elements in turning yourself into an informed and knowledgeable investor. In practicing this, you will also need to be selective and focused on certain industries in which you the have most interest and experience.

Successful investor habit 3: Have your own investment philosophy and system

What is an investment philosophy? An investment philosophy is a set of beliefs that you use as the foundation in developing your personal investment system for buying and selling investments. This will make sure you are fully aware of the reasons behind every investment decision you make. As a beginner in the investing world, you could probably start by following the investment philosophies and systems of some of the great investors that come closest to your heart.

However, along the way, you should tailor your investment system to suit your personality, goals and unique circumstances so that you can practice this entire system without stress and worries.

If you have the discipline to practice the right system religiously, you will not be easily influenced by the voices or rumours in the market and will not be tempted to simply follow the crowd. Hence, the chances of your making the wrong decisions will be minimised.

Successful investor habit 4: Be patient!

There is a Spanish proverb that says "The secret of patience is doing something else in the meantime". If you somehow managed to inculcate the above 3 habits, you will know exactly what you are looking for and as such, will be well equipped with the patience to wait for the right moment to buy or sell your stocks. Both Buffett and Soros stressed the fact that the secret of their success is having the patience to wait. Use your free time to explore and strategise other new opportunities as there are so many companies listed in the market. Always remember that identifying the right candidates does require time and patience.

On a last note, try to adopt the above habits now! Remember, good strategies will only be successful when executed with the right mindset!

This article was written by Securities Industry Development Corporation (SIDC) to educate investors on smart investing. The information provided in this article is for educational purposes only and should not be used as a substitute for legal or other professional advice.

SIDC, the leading capital markets education, training and information resource provider in Asean, is the training and development arm of the Securities Commission, Malaysia. It was established in 1994 and incorporated in 2007.

To invest or not to invest?

By TEE LIN SAY

IT is during desperate times such as these that great wealth is destroyed ... and created. While the media harps on the bankruptcies and collapse of reputable firms, it is important to know that opportunities to make money may have never been better.

Some of the biggest companies today were conceived in troubled times. For instance, Microsoft started in the recession of 1975, Hewlett Packard during the Great Depression and General Electric amid the Panic of 1873.

Clement Chew

Often, distress delivers valuable assets at fire sale prices. There are great opportunities to buy up or start a company, or to grab properties or stocks that will eventually be worth a lot more when the economy turns around. However, putting one’s cash to work when there is economic turmoil can be scary.

Does one hold cash or invest during a downturn? It is not an easy decision, as many people may have lost some of their wealth from investing in stocks, commodities or property following the boomtime of 2006 and 2007. Jaded investors may also be reluctant to sell their currently loss-making stocks and re-allocate the funds.

After being burnt, many would be more interested in licking their wounds and preserving whatever capital they have left.

With the large American and European banks in bad shape and the problem of debt deflation yet to be solved, it is safe to say that the current recession looks broad and lengthy. If investors hold this view, then wealth preservation ought to take precedence.

Financial experts always talk about the importance of investing in some form of asset class. Simply holding on to cash will not stave off the effects of inflation, they point out.

We are no longer experiencing a persistent increase in prices. The bigger fears are the stifled production and increasing unemployment. Nevertheless, inflation has an impact on the money we put aside for a rainy day.

In Malaysia, inflation is now 4.4% as of December 2008. With Bank Negara slashing interest rates by 75 basis points to 2.5% in January, there is effectively a 1.9% negative real interest rate on savings.

Lim Teck Seng

But should we worry if inflation eats into our savings? To some, it is still better than putting the money in the sagging markets for stocks, commodities or property.

Macquarie Research thinks otherwise. It suggests that investors move out of cash and into equities in the first quarter of 2009 because it expects a bear market rally in 2009.

It says: “Contrary to common belief, Malaysia is not a low volatility market. Therefore, investors should reweight Malaysia in the short term. Technically, investors have never been more underweight than now on Malaysia versus MSCI, so we could also benefit from liquidity.”

The decision to re-invest depends on a few things – the investor’s risk appetite, time horizon, and more importantly, outlook of the market.

Says MIDF-Amanah Investment Bank Bhd vice-president of dealing Lim Teck Seng: “While interest rates are extremely low, coupled with political changes and potential economic slowdown, psychologically, people feel that keeping money in the bank is safer.

“Everybody is thinking about security. Nobody is thinking about making money.”

His advice is to hold some 70% of one’s portfolio in cash, and the remainder in investments. He feels that the current crisis is something that has never happened before. Hence not even the best economist in the world can predict the recovery of the recession.

“People may say it is time to buy, but honestly, who will use their own money to do it?” Lim asks.

“For instance, if a person already has a house, he will put off his initial idea of buying another house for investment. He may miss out on the rental yield of the house, but who cares? Even worse is the prospect of losing his principal amount!”

He says few people really bother about deposit rates at current times. “They don’t mind if the rates go to zero, as long as their cash is preserved,” he adds.

JP Morgan Securities (M) Sdn Bhd senior country officer and equities broking head Clement Chew says that in the present volatile market, many investors are risk-averse and prefer to sit on cash.

“Given the global volatility, I would suggest looking at defensive dividend yield stocks if you want to be in the market,” he adds.

He points out that defensive stocks such as British American Tobacco (M) Bhd, DiGi.Com Bhd and Berjaya Sports Toto Bhd have fared well when compared against the Kuala Lumpur Composite Index, due to their dividend yields.

“If you think markets are going to recover, then its time to go for the higher beta cyclical stocks. For now, we prefer stocks that have resilient earnings,” Chew says.

Lim, however, feels that investors would rather jump into a rally much later, rather than get stuck buying a stock too early.

“It is mainly the fund managers that go for dividends. Retailers and high net worth individuals are more interested in capital appreciation,” he says.

He does not advocate buying a stock purely for its high dividends. “Let’s say you buy a stock that gives a 10 sen dividend per year. What if today the stock price drops 10 sen. Then you have to wait a year to get your 10 sen dividend,” he argues.

Furthermore, given the difficult economic and business conditions, companies may also change their dividend policies to conserve cash.

Deposits in the banking system increased significantly in December by about 12% to RM972.4bil. The increase was said to be due to the Government’s payments for development projects and bonuses to civil servants. However, much of the money appears to remain in bank accounts.

“If people were really buying stocks, why are the volumes on Bursa Malaysia still so weak? People are thinking of security,” says Lim.

He adds that stock picking is increasingly difficult. “People used to say blue chips were safe. But last year, it was the blue chips that got pummelled. Plantation stocks used to be considered premium stocks, but look what has happened,” he says.

Chew believes that opting for short-term trading strategies in a volatile market is risky. “Even the best investors find it difficult to time such a market. You should switch out of defensive dividend yield stocks when there are clearer signs of a bottom,” he says.

Risk Tolerance Quiz

Insight into bonds

Find out what is a bond; why invest in it; and what to watch out for when investing in bonds.

MALAYSIAN retail investors have never participated actively in bond investing.

Some of you may have bought bond funds offered by the unit trusts, however, most of you may not know what a bond investment is really about and the effect it has on your investment portfolio.

So then… what is a bond?

A bond represents the debt owed by either government units or corporations.

By investing in bonds, you basically become the lender to the issuers and you will be paid a specified percentage of interest.

This percentage of interest is called coupon payment and it is given to you by the issuer because of the use of your money.

At the end of the maturity date, you will get back your principal.

An example to quote is the Bond Simpanan Merdeka 2008 issued by Bank Negara for the senior citizens, which has a three-year tenure and pays 5 per cent interest per year.

In Malaysia, the main issuers of public debt are the government of Malaysia,Bank Negara Malaysia), and quasi government institutions (Khazanah, Danamodal and Danaharta).

Private debt securities and asset-backed securities are issued by the National Mortgage Corporation (Cagamas Bhd), financial institutions and non-financial corporations.

The major investors in the Malaysian bond market are the Employees Provident Fund (EPF), pension funds, insurance companies and other financial institutions.

The price of a bond is determined by many factors, with the main drivers being interest rates, inflation, maturity and credit quality.

Interest rates

Bonds are highly sensitive to interest rate fluctuations.

When the prevailing interest rate goes up higher than the coupon rate, the prices of the outstanding bonds will fall below the principal value.

If you are buying a bond fund, higher interest rates will cause lower fund prices.

Inflation
During periods of rapid economic growth, we will see increasing inflation.

This will eventually lead to higher interest rates and cause a drop in the value of bonds.

Deflation, the opposite of inflation, may occur when there is a recession or prolonged periods or little or no growth and excess capacity, will eventually lead to zero or negative real interest rates, causing the value of bonds to rise.

Maturity

Due to the sensitivities to inflation and interest rate fluctuations, longer term bonds will face more uncertainties compared to shorter term bonds.

As such, longer term bonds should offer better interest payments as the additional risk premium for the investors.

Nevertheless, they will suffer larger price fluctuations as a result of the longer period they take to mature.

Credit quality

When we lend out our money, we want to make sure that we will be able to get it back.

Therefore, the credibility or credit quality of the bond issuers plays an important role in the bond price.

A corporate bond will have a higher yield than a government guaranteed bond due to the additional risk that the investor has to bear for facing the possibility of the corporate bond defaulting.

The recent global financial crisis was partly attributed to the decline in credit quality for certain corporate bonds.

Why invest in bonds

Investing in bonds offers an alternative to investors to diversify their investment portfolios because it is relatively lower risk compared to stock investing.

As bonds provide periodic interest payments and repayment of principal at the end of the maturity, it will be suitable for you if your investment objective is to preserve capital and receive a predictable stream of income.

Depending on your investment time horizon, you can choose to invest in short-, medium- or long-term bonds.

However, you must understand the factors that drive the price of the bond that you
invest in.

As retailers, most of the time we will be investing in bond funds offered by unit trusts or commercial banks.

Bond funds are combinations of various bonds, therefore, the risk of investing in bond funds is relatively lower compared to individual bonds.

However, you must take note of the factors listed above while selecting an appropriate bond fund.

In addition, you will also need to know about the fund management companies and make sure that the approaches they take are suitable for your risk profile and investment objectives.

The timing of investing in bond funds is also very important.

What to watch out for when investing in bonds

Watch out for the interest rate especially if it is too low or unstable.

Avoid speculative bonds. Even when you are investing in bond funds, make sure that the bonds in the portfolio are investment grade, which carries a credit rating of “BBB” and above.

Bonds with rating of “BB” and below are considered “high yield” and below investment grade.

Don’t invest a large portion of your portfolio in bonds. It will limit your portfolio growth, as over time, inflation will erode the fixed income stream and principal.

Bonds are suitable to complement stock investing.

This article was written by SIDC and Ooi Kok Hwa, a holder of a Capital Markets Services Representative’s Licence to carry on the business of investment advice under the Capital Markets and Services Act 2007.

The information provided in this article is for educational purposes only and should not be used as a substitute for legal or other professional advice.

Securities Industry Development Corp, the leading capital markets education, training and information resource provider in Asean, is the training and development arm of the Securities Commission.

It was established in 1994 and incorporated in 2007.

Understand various standards of value

Although they appear to be the same, there are distinctive differences

THERE has been a lot of misunderstanding about the standards of value. There are six common standards of value: fair-market value, intrinsic value, book value, investment value, liquidation value and fair value.

To most investors, they appear to be the same. However, there are distinctive differences between them. We should use different stardards of value for different business scenarios and purposes.

Fair market value (FMV)

This is the most commonly used standard of value in any business appraisal. It is frequently used when we buy or sell a property asset or a company, especially a private limited company. It is defined as the price at which the asset or company would change hands between a willing buyer and willing seller, each acting with complete information about the company and under no unusual duress.

Note that buyers and sellers should have all the relevant information about the asset and not be under compulsion to buy or sell. In view of the current weak economic situation, if the seller is forced to sell his property to reduce his debts, the transacted value is not FMV. One of the key characteristics of this FMV is the seller should not be under any pressure to sell the asset.

It is always difficult, especially to the buyer, to obtain all the relevant information on any particular asset or company. In most times, the seller has more information than the buyer. Hence, to comply with this standard, the seller is required to disclose all relevant information pertinent to this asset to the buyer before selling this asset.

Intrinsic value

This is the value derived or computed by research analysts. According to Benjamin Graham, it is driven by the earnings power of a company. Sometimes we may wonder why different analysts derive different target prices for the same listed company.

If you understand the expression “Beauty is in the eye of the beholder”, you should be able to understand that different analysts would generate different target prices for the same company.

According to the fundamental principles of any investment analysis, as long as the analysts have reasonable basis to derive the final target number, it will be accepted as the intrinsic value of the company.

Book value

This is computed by the difference between a company’s assets and liabilities. Sometimes we can also label it as the value of the owners’ equity, net worth or shareholders’ equity. This value will reflect the total cost or total money invested in the company.

Under a normal economic environment, it will be very difficult to find a company’s market price selling lower than its book value. However, as a result of the current weak economic and stock market condition, a lot of listed companies have been selling lower than their book value.

Investment value

This value is only applicable to a particular buyer and not the population of willing buyers. It is the value that a particular buyer will generate from investing in the asset.

Different buyers have different investment objectives and different financial positions. As a result, different buyers will generate different cashflows and profits for the same asset.

For example, for the same shoplot, one may use it for education purposes whereas another may open a restaurant. The cashflows that can be generated from education or restaurant businesses will not be the same.

Hence, different buyers will have different investment value from the same asset.

Liquidation value

Under a normal business environment, we hardly use this value as we always value any assets or companies as a going concern where we assume the business is up and running and active in its pursuit of revenue and profits.

If we intend to close down or liquidate a company, we will use liquidation value as it is the value of the company upon disposition of all tangible and intangible assets. There are two levels of this value whether it is part of a planned or a forced liquidation. The value generated from a forced liquidation will be the lowest as all assets will be disposed in the shortest possible period of time.

Fair value

This is subject to the interpretation by the court officials overseeing the transaction. In any dispute, the final value determined by the court will be viewed as fair value, which is fair to the buyer and seller.

● Ooi Kok Hwa is an investment adviser and managing partner of MRR Consulting.