Relying on fund managers

I started out in the world of investing about 7 years ago. Thinking that it was wiser to get a professional to manage my money rather an amateur like myself, I started off using unit trust fund managers. Being an engineer with no formal financial training, I thought I had better steer clear of the financial markets because I have relatives who got seriously burned. Later, the more I knew about the investing business, the more I steered clear of them. I have nothing against fund managers. I sincerely believe the average IQ of mutual fund managers to be higher than mine and the bottom 5% of hedge fund managers to be much higher than mine. I also do not think they are a untrustworthy group of people. I think they are just normal people who will not place their clients' interests high on the list if the system does not reward them for doing so.

What makes me uncomfortable is that the nature of the money management business has conflicts of interests that put their clients at a disadvantage.

The annual fund management fees provide an incentive to grow the size of their asset under management. It is easier to make an investment returns of 20% on SGD200k than SGD200million. The universe of applicable investment ideas diminishes as the portfolio size grows. Liquidity becomes a greater problem. It is harder to find an investment large enough to absorb your funds to make a difference big enough to move the performance needle when you get it right. On the other hand, if you get it wrong, it is much more expensive to get out due to the slippage and commission fees caused from liquidating a large position. A growing portfolio size is sure to dampen investment returns. An incentive to grow the asset size under management works against the clients.

Career risk distorts fund managers' investing decisions. It makes sense for fund managers to follow the crowd to reduce career risk. If they follow the crowd and get it wrong, clients are more forgivable. If they go against the crowd and get it wrong, they may lose their jobs. During the crazy dot-com bubble, several fund managers of the Graham-and-Dodd school of value investing lost their jobs. If I were a fund manager, I will not invest the same way as I will with my own money. Even hedge fund managers whose stated goal is absolute returns may unconsciously strive for relative returns because of the career risk of disagreeing with the crowd. This could explain why clients of hedge funds who were promised alpha (outperformance over benchmark) ended up with beta (correlation with benchmark). One might as well buy ETFs which I think is the best investing instrument for non-DIY investors. Why pay so much for hedge fund managers if they end up trying to match the benchmark index? One might as well buy cheap ETFs correlated with indices which outperformed most fund managers anyway. The high IQs of fund managers cannot be put to maximum use because they do not solely buy and sell on investment merit but on career risk considerations as well.

I think the best money managers out there are still the hedge fund managers. However, they are out of reach for most middle-class income people like me. If I were eligible someday for their service, I will go for fund managers with zero annual management fees with most of their net worth in their own fund. Their profits will come from outperforming a high watermark. With such a structure, there will be no conflict of interests. There will be no incentive to grow asset size. Career risk takes a backseat to investment risk because if they lose 1% of my net worth, they will lose 10% of their own.

I shall now stop dreaming of that day when I do become eligible. 

Cash becoming a risky asset class because of beast contest

Investing is like a beauty contest. You pick the most beautiful contestant and if the other judges share your opinion, you will make big money. In the stock market, you pick the best stocks with the best potential for capital appreciation and dividend income.

On the other hand, today's currency market is like a beast contest. All the contestants are ugly. Central bankers have disfigured the contestants with their quantitative easing knives and used printed money to bandage their faces. A currency investor tries to pick the least ugly contestant.

My knowledge in currency markets is limited. I do not invest in forex markets because I do not see how an engineer like me with no formal financial training and holding a full-time job can gain an edge over the big financial institutions who can afford to pay smarter minds and provide them with greater resources and time for the job. However, no one can totally ignore the currency markets because it will affect us whether we like it or not. All of us must have cash savings in the form of paper currency. The excessive money printing has render our cash savings increasingly risky as an asset class.

In the short-term, it is uncertain whether deflation or inflation will win out. The financial markets are giving out confusing signals. The gold market suggests that inflation is on the way. The bond market suggests that deflation is coming. In the short term, your guess is as good as mine. However, in the long-term, I will place my bet on inflation.

If deflation rears its ugly head, deflationary forces can be defeated by central bankers through money-printing which is politically acceptable. Alan Greenspan became a celebrated maestro by slashing interest rates to save financial markets whenever Wall Street cries out for help. Paul Volcker was universally hated when he raised interest rates to defeat high inflation in the late 1970s. There is an abundance of regulators who prefer to take the easy, populist route like cutting interest rates and becoming a Wall Street hero (highly rewarding when you join Wall Street later). On the other hand, there is a scarcity of regulators who have the integrity and courage to do what is right, especially if the career risk is not worth it personally.

If inflation rears its ugly head, inflationary forces may not be as easily defeated by central bankers because the country has got to be quite lucky to have another Paul Volcker. Even if the country does have a Paul Volcker reincarnated, he might not have the support of his political master. Debt level today is way much more as compared to the late 1970s. Massive debts have been built up by governments through quantitative easing. By raising interest rates on a huge debt, it is like committing financial suicide when tax revenues eventually cannot service the interest payments. In such a situation, it is politically impossible for the central banker to raise interest rates to kill inflation. What is politically acceptable then and more likely to happen is to allow inflation to kill the burden of debt instead. Besides, much of US debt is held by foreigners. I cannot imagine Obama making a speech to his fellow Americans to tighten their belts so that they can honor their debt to the Chinese. This is political suicide. In a democracy, no politician will antagonize their people who carry votes to appease foreigners with no votes. The easy way out for a politician is to allow inflation and currency debasement to ease the burden of debt to the locals by destroying the value of debt to foreigners. In this event, cash savings in USD will be devastated.

This pessimistic analysis applies for the US situation. However, all countries outside the United States cannot  ignore what happens there. The US dollar is the world's reserve currency. Much of global trade is done in USD. The world's raw materials are priced in USD. Whether they like the USD or not, corporations have to keep a USD bank account because their products or their raw materials are traded in USD. Impact from bad policies by the Federal Reserve will be exported out to the rest of the world.

Inflation is a politically convenient tool to solve sovereign debt problems. This is likelier to happen in highly democratic countries which tends to surrender to the popular vote than in dictatorial countries where politicians simply force unpopular policies down the voters' throats. This is one of the reasons that I think the Singapore dollar looks less ugly than the other beasts at the moment.

Smoking - Things to avoid to preserve your wealth

I have never smoked a single cigarette in my life ever. The purpose of this post is not to talk down to smokers like a parent lecturing his child on why smoking is bad for you. I am not qualified to do that. On an intellectual level, which smoker does not know smoking kills and is harmful to the family? I would like to list down the reasons why I avoid cigarettes the way I avoid the casino with a ten-foot pole.

- Smoking is particularly injurious to your pocket in Singapore.  

Like cars, Singapore is one of the most expensive place to buy cigarettes. Cigarette prices range between SGD8 to SGD15. I am not aware of other countries which sell cigarettes more expensive than Singapore. Smoking is a very expensive indulgence in Singapore.

- Easy target to be picked on by government to raise tax revenue

Smokers are the easiest target group to be picked on by the government to raise tax revenue. It is politically acceptable because most people are non-smokers and they are more than happy to see cigarette prices go up to discourage smokers from polluting the air. To appease the smoker, the government can offer the political viable reason that it is raising the levy for the good of the smokers themselves to stop them from harming themselves and their family.

All governments love to implement policies that can make money off the people while at the same time be seen as doing something good for the people.

Governments need not fear tax revenue from cigarettes will drop drastically due to price increases. In economist terms, cigarettes are price inelastic. This means that demand for cigarettes will hardly change despite price increases. Any product of an addictive nature enjoy the price-inelastic characteristic. A wonderful business will sell products with this kind of characteristic.

- More expensive insurance premium

Smokers have to pay more expensive premiums for their health insurance policies to compensate the insurer for the increased health risk they are undertaking. Smokers can lie to the insurer but they face the risk of being denied claims later. It is not worth the risk. Why risk buying an umbrella that cannot open when it starts raining?

- Increased risk of higher medical bill

Doctors can be highly damaging to your pocket. Unexpected medical problems is a commonly cited reason for middle-class families to slip into poverty. Smokers put themselves and their families (if they are breadwinners) at higher risk of slipping into poverty house.

In Singapore, the poor complains that it is better for them to die than to fall sick. While doctors can save you from a heart attack, their bills can send you another round of heart attack. Smoking brings you one step closer to the doctor. A cigarette a day ensures the doctor's pay (at the smoker's expense).

- Loss of health which impact earnings

Our greatest asset, as able-bodied people, is our ability to earning a living. A failing health will take this asset away. As advertised on every cigarette pack, smoking kills and harms your health. Otherwise, why would insurer charge the extra premium?

- Harmful to pregnant women and kids

Smoking is harmful to pregnant women and raises the chance of having babies with defects. Inhalation of smoke is also bad for the brain development of growing infants/kids. If you want to depend on your children to take care of you in old age, you have to ensure they grow up in a healthy environment.

- Non-smoking bosses do not like smokers

Smokers take breaks during work to smoke. Bosses frown upon the lost productivity from smokers although most keep quiet about it. Some smokers claim smoking helps them concentrate better and aids their memory. Don't say this to your non-smoking bosses. They will probably take this as some kind of bullshit. It is hard to quantify how career prospects are affected when appraised by a non-smoking boss.

- Smokers are not welcomed by non-smokers
Non-smokers do not like smokers who smoke in front of them. They are just being polite when they say ok to a smoker who asks if it is ok to smoke. My wife has made it clear to me that she would not marry me if I were a smoker. That would be a tremendous, unmeasurable loss personally.

Smoking, like the consumption of alcohol and other harmful addictive chemicals, is like spending hard-earned money to harm myself and my family. Therefore, it is not rational to smoke.