Category: Personal Thoughts

9 years 7 months and 6 days. This is how much time has passed since I started managing my family’s investment portfolio of US stocks on 26 October 2010. 19.5% versus 12.7%. These are the respective annual returns of my family’s portfolio (without dividends) and the S&P 500 (with dividends) in that period.

I will soon have to say goodbye to the portfolio. Jeremy Chia (my blogging partner) and myself have co-founded a global equities investment fund. As a result, the lion’s share of my family’s investment portfolio will soon be liquidated so that the cash can be invested in the fund. 

The global equities investment fund will be investing with the same investment philosophy that underpins my family’s portfolio, so the journey continues. But my heart’s still heavy at having to let the family portfolio go. It has been a huge part of my life for the past 9 years 7 months and 6 days, and I’m proud of what I’ve achieved (I hope my parents are too!).

In the nearly-10 years managing the portfolio, I’ve learnt plenty of investing lessons. I want to share them here, to benefit those of you who are reading, and to mark the end of my personal journey and the beginning of a new adventure. I did not specifically pick any number of lessons to share. I’m documenting everything that’s in my head after a long period of reflection. 

Do note that my lessons may not be timeless, because things change in the markets. But for now, they are the key lessons I’ve picked up. 

Lesson 1: Focus on business fundamentals, not macroeconomic or geopolitical developments – there are always things to worry about

My family’s portfolio has many stocks that have gone up multiple times in value. A sample is given below:

Some of them are among the very first few stocks I bought; some were bought in more recent years. But what’s interesting is that these stocks produced their gains while the world experienced one crisis after another.

You see, there were always things to worry about in the geopolitical and macroeconomic landscape since I started investing. Here’s a short and incomplete list (you may realise how inconsequential most of these events are today, even though they seemed to be huge when they occurred):

• 2010 – European debt crisis; BP oil spill; May 2010 Flash Crash
• 2011 – Japan earthquake; Middle East uprising
• 2012 – Potential Greek exit from Eurozone; Hurricane Sandy
• 2013 – Cyprus bank bailouts; US government shutdown; Thailand uprising
• 2014 – Oil price collapse
• 2015 – Crash in Euro dollar against the Swiss Franc; Greece debt crisis
• 2016 – Brexit; Italy banking crisis
• 2017 – Bank of England hikes interest rates for first time in 10 years
• 2018 – US-China trade war
• 2019 – Australia bushfires; US President impeachment; appearance of COVID-19 in China
• 2020 (thus far) – COVID-19 becomes global pandemic

The stocks mentioned in the table above produced strong business growth over the years I’ve owned them. This business growth has been a big factor in the returns they have delivered for my family’s portfolio. When I was studying them, my focus was on their business fundamentals – and this focus has served me well.

In a 1998 lecture for MBA students, Warren Buffett was asked about his views on the then “tenuous economic situation and interest rates.“ He responded:

“I don’t think about the macro stuff. What you really want to do in investments is figure out what is important and knowable. If it is unimportant and unknowable, you forget about it. What you talk about is important but, in my view, it is not knowable.

Understanding Coca-Cola is knowable or Wrigley’s or Eastman Kodak. You can understand those businesses that are knowable. Whether it turns out to be important depends where your valuation leads you and the firm’s price and all that. But we have never not bought or bought a business because of any macro feeling of any kind because it doesn’t make any difference.

Let’s say in 1972 when we bought See’s Candy, I think Nixon [referring to former US President, Richard Nixon] put on the price controls a little bit later, but so what! We would have missed a chance to buy something for [US]$25 million that is producing [US]$60 million pre-tax now. We don’t want to pass up the chance to do something intelligent because of some prediction about something we are no good on anyway.”

Lesson 2: Adding to winners work

I’ve never shied away from adding to the winners in my portfolio, and this has worked out well. Here’s a sample, using some of the same stocks shown in the table in Lesson 1.

Adding to winners is hard to achieve, psychologically. As humans, we tend to anchor to the price we first paid for a stock. After a stock has risen significantly, it’s hard to still see it as a bargain. But I’ll argue that it is stocks that have risen significantly over a long period of time that are the good bargains. It’s counterintuitive, but hear me out.

The logic here rests on the idea that stocks do well over time if their underlying businesses do well. So, the stocks in my portfolio that have risen significantly over a number of years are likely – though not always – the ones with businesses that are firing on all cylinders. And stocks with businesses that are firing on all cylinders are exactly the ones I want to invest in. 

Lesson 3: The next Amazon, is Amazon

When I first bought shares of Amazon in April 2014 at US$313, its share price was already more than 200 times higher than its IPO share price of US$1.50 in May 1997. That was an amazing annual return of around 37%.

But from the time I first invested in Amazon in April 2014 to today, its share price has increased by an even more impressive annual rate of 40%. Of course, it is unrealistic to expect Amazon to grow by a further 200 times in value from its April 2014 level over a reasonable multi-year time frame. But a stock that has done very well for a long period of time can continue delivering a great return. Winners often keep on winning.    

Lesson 4: Focus on business quality and don’t obsess over valuation

It is possible to overpay for a company’s shares. This is why we need to think about the valuation of a business. But I think it is far more important to focus on the quality of a business – such as its growth prospects and the capability of the management team – than on its valuation.

If I use Amazon as an example, its shares carried a high price-to-free cash flow (P/FCF) ratio of 72 when I first invested in the company in April 2014. But Amazon’s free cash flow per share has increased by 1,000% in total (or 48% annually) from US$4.37 back then to US$48.10 now, resulting in the overall gain of 681% in its share price.

Great companies could grow into their high valuations. Amazon’s P/FCF ratio, using my April 2014 purchase price and the company’s current free cash flow per share, is just 6.5 (now that’s a value stock!). But there’s no fixed formula that can tell you what valuation is too high for a stock. It boils down to subjective judgement that is sometimes even as squishy as an intuitive feeling. This is one of the unfortunate realities of investing. Not everything can be quantified.   

Lesson 5: The big can become bigger – don’t obsess over a company’s market capitalisation

I’ve yet to mention Mastercard, but I first invested in shares of the credit card company on 3 December 2014 at US$89 apiece. Back then, it already had a huge market capitalisation of around US$100 billion, according to data from Ycharts. Today, Mastercard’s share price is US$301, up more than 200% from my initial investment. 

A company’s market capitalisation alone does not tell us much. It is the company’s (1) valuation, (2) size of the business, and (3) addressable market, that can give us clues on whether it could be a good investment opportunity. In December 2014, Mastercard’s price-to-earnings (P/E) ratio and revenue were both reasonable at around 35 and US$9.2 billion, respectively. Meanwhile, the company’s market opportunity still looked significant, since cashless transactions represented just 15% of total transactions in the world back then.

Lesson 6: Don’t ignore “obvious” companies just because they’re well known

Sticking with Mastercard, it was an obvious company that was already well-known when I first invested in its shares. In the first nine months of 2014, Mastercard had more than 2 billion credit cards in circulation and had processed more than 31.4 billion transactions. Everyone could see Mastercard and know that it was a great business. It was growing rapidly and consistently, and its profit and free cash flow margins were off the charts (nearly 40% for both).

The company’s high quality was recognised by the market – its P/E ratio was high in late 2014 as I mentioned earlier. But Mastercard still delivered a fantastic annual return of around 25% from my December 2014 investment.

I recently discovered a poetic quote by philosopher Arthur Schopenhauer: “The task is… not so much to see what no one has yet seen, but to think what nobody has yet thought, about that which everyone sees.” This is so applicable to investing.

Profitable investment opportunities can still be found by thinking differently about the data that everyone else has. It was obvious to the market back in December 2014 that Mastercard was a great business and its shares were valued highly because of this. But by thinking differently – with a longer-term point of view – I saw that Mastercard could grow at high rates for a very long period of time, making its shares a worthy long-term investment. From December 2014 to today, Mastercard’s free cash flow per share has increased by 158% in total, or 19% per year. Not too shabby.   

Lesson 7: Be willing to lose sometimes

We need to take risks when investing. When I first invested in Shopify in September 2016, it had a price-to-sales (P/S) ratio of around 12, which is really high for a company with a long history of making losses and producing meagre cash flow. But Shopify also had a visionary leader who dared to think and act long-term. Tobi Lütke, Shopify’s CEO and co-founder, penned the following in his letter to investors in the company’s 2015 IPO prospectus (emphases are mine):

“Over the years we’ve also helped foster a large ecosystem that has grown up around Shopify. App developers, design agencies, and theme designers have built businesses of their own by creating value for merchants on the Shopify platform. Instead of stifling this enthusiastic pool of talent and carving out the profits for ourselves, we’ve made a point of supporting our partners and aligning their interests with our own. In order to build long-term value, we decided to forgo short-term revenue opportunities and nurture the people who were putting their trust in Shopify. As a result, today there are thousands of partners that have built businesses around Shopify by creating custom apps, custom themes, or any number of other services for Shopify merchants.

This is a prime example of how we approach value and something that potential investors must understand: we do not chase revenue as the primary driver of our business. Shopify has been about empowering merchants since it was founded, and we have always prioritized long term value over short-term revenue opportunities. We don’t see this changing…

… I want Shopify to be a company that sees the next century. To get us there we not only have to correctly predict future commerce trends and technology, but be the ones that push the entire industry forward. Shopify was initially built in a world where merchants were simply looking for a homepage for their business. By accurately predicting how the commerce world would be changing, and building what our merchants would need next, we taught them to expect so much more from their software.

These underlying aspirations and values drive our mission: make commerce better for everyone. I hope you’ll join us.”       

Shopify was a risky proposition. But it paid off handsomely. In investing, I think we have to be willing to take risks and accept that we can lose at times. But failing at risk-taking from time to time does not mean our portfolios have to be ruined. We can take intelligent risks by sizing our positions appropriately. Tom Engle is part of The Motley Fool’s investing team in the US. He’s one of the best investors the world has never heard of. When it comes to investing in risky stocks that have the potential for huge returns, Tom has a phrase I love: “If it works out, a little is all you need; if it doesn’t, a little is all you want.” 

I also want to share a story I once heard from The Motley Fool’s co-founder Tom Gardner. Once, a top-tier venture capital firm in the US wanted to improve the hit-rate of the investments it was making. So the VC firm’s leaders came up with a process for the analysts that could reduce investing errors. The firm succeeded in improving its hit-rate (the percentage of investments that make money). But interestingly, its overall rate of return became lower. That’s because the VC firm, in its quest to lower mistakes, also passed on investing in highly risky potential moonshots that could generate tremendous returns.

The success of one Shopify can make up for the mistakes of many other risky bets that flame out. To hit a home run, we must be willing to miss at times.  

Lesson 8: The money is made on the holding, not the buying and selling

My family’s investment portfolio has over 50 stocks. It’s a collection that was built steadily over time, starting with the purchase of just six stocks on 26 October 2010. In the 9 years, 7 months and 6 days since, I’ve only ever sold two stocks voluntarily: (1) Atwood Oceanics, an owner of oil rigs; and (2) National Oilwell Varco, a supplier of parts and equipment that keep oil rigs running. Both stocks were bought on 26 October 2010.

David Gardner is also one of the co-founders of The Motley Fool (Tom Gardner is his brother). There’s something profound David once said about portfolio management that resonates with me:

“Make your portfolio reflect your best vision for our future.” 

The sales of Atwood Oceanics and National Oilwell Varco happened because of David’s words. Part of the vision I have for the future is a world where our energy-needs are met entirely by renewable sources that do not harm the precious environment we live in. For this reason, I made the rare decision to voluntarily part ways with Atwood Oceanics and National Oilwell Varco in September 2016 and June 2017, respectively.

My aversion to selling is by design – because I believe it strengthens my discipline in holding onto the winners in my family’s portfolio. Many investors tend to cut their winners and hold onto their losers. Even in my earliest days as an investor, I recognised the importance of holding onto the winners in driving my family portfolio’s return. Being very slow to sell stocks has helped me hone the discipline of holding onto the winners. And this discipline has been a very important contributor to the long run performance of my family’s portfolio.

The great Charlie Munger has a saying that one of the keys to investing success is “sitting on your ass.” I agree. Patience is a virtue. And talking about patience… 

Lesson 9: Be patient – some great things take time

Some of my big winners needed only a short while before they took off. But there are some that needed significantly more time. Activision Blizzard is one such example. As I mentioned earlier, I invested in its shares in October 2010. Then, Activision Blizzard’s share price went nowhere for more than two years before it started rocketing higher.

Peter Lynch once said: “In my investing career, the best gains usually have come in the third or fourth year, not in the third or fourth week or the third or fourth month.” The stock market does not move according to our own clock. So patience is often needed.

Lesson 10: Management is the ultimate source of a company’s economic moat

In my early days as an investor, I looked for quantifiable economic moats. These are traits in a company such as (1) having a network effect, (2) being a low-cost producer, (3) delivering a product or service that carries a high switching cost for customers, (4) possessing intangible assets such as intellectual property, and (5) having efficient scale in production. 

But the more I thought about it, the more I realised that a company’s management team is the true source of its economic moat, or lack thereof.

Today, Netflix has the largest global streaming audience with a pool of 183 million subscribers around the world. Having this huge base of subscribers means that Netflix has an efficient scale in producing content, because the costs can be spread over many subscribers. Its streaming competitors do not have this luxury. But this scale did not appear from thin air. It arose because of Netflix’s CEO and co-founder, Reed Hastings, and his leadership team.

The company was an early pioneer in the streaming business when it launched its streaming service in 2007. In fact, Netflix probably wanted to introduce streaming even from its earliest days. Hastings said the following in a 2007 interview with Fortune magazine: 

“We named the company Netflix for a reason; we didn’t name it DVDs-by-mail. The opportunity for Netflix online arrives when we can deliver content to the TV without any intermediary device.”

When Netflix first started streaming, the content came from third-party producers. In 2013, the company launched its first slate of original programming. Since then, Netflix has ramped up its original content budget significantly. The spending has been done smartly, as Netflix has found plenty of success with its original programming. For instance, in 2013, the company became the first streaming provider to be nominated for a primetime Emmy. And in 2018 and 2019, the company snagged 23 and 27 Emmy wins, respectively.  

A company’s current moat is the result of management’s past actions; a company’s future moat is the result of management’s current actions. Management is what creates the economic moat.

Lesson 11: Volatility in stocks is a feature, not a bug

Looking at the table in Lesson 1, you may think that my investment in Netflix was smooth-sailing. It’s actually the opposite. 

I first invested in Netflix shares on 15 September 2011 at US$26 after the stock price had fallen by nearly 40% from US$41 in July 2011. But the stock price kept declining afterward, and I bought more shares at US$16 on 20 March 2012. More pain was to come. In August 2012, Netflix’s share price bottomed at less than US$8, resulting in declines of more than 70% from my first purchase, and 50% from my second.  

My Netflix investment was a trial by fire for a then-young investor – I had started investing barely a year ago before I bought my first Netflix shares. But I did not panic and I was not emotionally affected. I already knew that stocks – even the best performing ones – are volatile over the short run. But my experience with Netflix drove the point even deeper into my brain.

Lesson 12: Be humble – there’s so much we don’t know

My investment philosophy is built on the premise that a stock will do well over time if its business does well too. But how does this happen?

In the 1950s, lawmakers in the US commissioned an investigation to determine if the stock market back then was too richly priced. The Dow (a major US stock market benchmark) had exceeded its peak seen in 1929 before the Great Depression tore up the US market and economy. Ben Graham, the legendary father of value investing, was asked to participate as an expert on the stock market. Here’s an exchange during the investigation that’s relevant to my discussion:

“Question to Graham: When you find a special situation and you decide, just for illustration, that you can buy for 10 and it is worth 30, and you take a position, and then you cannot realize it until a lot of other people decide it is worth 30, how is that process brought about – by advertising, or what happens?

Graham’s response: That is one of the mysteries of our business, and it is a mystery to me as well as to everybody else. We know from experience that eventually the market catches up with value. It realizes it in one way or another.”   

More than 60 years ago, one of the most esteemed figures in the investment business had no idea how stock prices seemed to eventually reflect their underlying economic values. Today, I’m still unable to find any answer. If you’ve seen any clues, please let me know! This goes to show that there’s so much I don’t know about the stock market. It’s also a fantastic reminder for me to always remain humble and be constantly learning. Ego is the enemy.  

Lesson 13: Knowledge compounds, and read outside of finance

Warren Buffett once told a bunch of students to “read 500 pages… every day.” He added, “That’s how knowledge works. It builds up, like compound interest. All of you can do it, but I guarantee not many of you will do it.” 

I definitely have not done it. I read every day, but I’m nowhere close to the 500 pages that Buffett mentioned. Nonetheless, I have experienced first hand how knowledge compounds. Over time, I’ve been able to connect the dots faster when I analyse a company. And for companies that I’ve owned shares of for years, I don’t need to spend much time to keep up with their developments because of the knowledge I’ve acquired over the years.

Reading outside of finance has also been really useful for me. I have a firm belief that investing is only 5% finance and 95% everything else. Reading about psychology, society, history, science etc. can make us even better investors than someone who’s buried neck-deep in only finance books. Having a broad knowledge base helps us think about issues from multiple angles. This brings me to Arthur Schopenhauer’s quote I mentioned earlier in Lesson 6:  “The task is… not so much to see what no one has yet seen, but to think what nobody has yet thought, about that which everyone sees.”

Lesson 14: The squishy things matter

Investing is part art and part science. But is it more art than science? I think so. The squishy, unquantifiable things matter. That’s because investing is about businesses, and building businesses involves squishy things.

Jeff Bezos said it best in his 2005 Amazon shareholders’ letter (emphases are mine):

“As our shareholders know, we have made a decision to continuously and significantly lower prices for customers year after year as our efficiency and scale make it possible. This is an example of a very important decision that cannot be made in a math-based way.

In fact, when we lower prices, we go against the math that we can do, which always says that the smart move is to raise prices. We have significant data related to price elasticity. With fair accuracy, we can predict that a price reduction of a certain percentage will result in an increase in units sold of a certain percentage. With rare exceptions, the volume increase in the short term is never enough to pay for the price decrease.

However, our quantitative understanding of elasticity is short-term. We can estimate what a price reduction will do this week and this quarter. But we cannot numerically estimate the effect that consistently lowering prices will have on our business over five years or ten years or more.

Our judgment is that relentlessly returning efficiency improvements and scale economies to customers in the form of lower prices creates a virtuous cycle that leads over the long term to a much larger dollar amount of free cash flow, and thereby to a much more valuable Amazon.com. We’ve made similar judgments around Free Super Saver Shipping and Amazon Prime, both of which are expensive in the short term and—we believe—important and valuable in the long term.”

On a related note, I was also attracted to Shopify when I came across Tobi Lütke’s letter to investors that I referenced in Lesson 7. I saw in Lütke the same ability to stomach short-term pain, and the drive toward producing long-term value, that I noticed in Bezos. This is also a great example of how knowledge compounds. 

Lesson 15: I can never do it alone

Aaron Bush is one of the best investors I know of at The Motley Fool, and he recently created one of the best investing-related tweet-storms I have seen. In one of his tweets, he said: “Collaboration can go too far. Surrounding yourself with a great team or community is critical, but the moment decision-making authority veers democratic your returns will begin to mean-revert.” 

I agree with everything Aaron said. Investment decision-making should never involve large teams. But at the same time, having a community or team around us is incredibly important for our development; their presence enables us to view a problem from many angles, and it helps with information gathering and curation.

I joined one of The Motley Fool’s investment newsletter services in 2010 as a customer. The service had wonderful online forums and this dramatically accelerated my learning curve. In 2013, I had the fortune to join an informal investment club in Singapore named Kairos Research. It was founded by Stanley Lim, Cheong Mun Hong, and Willie Keng. They are also the founders of the excellent Asia-focused investment education website, Value Invest Asia. I’ve been a part of Kairos since and have benefited greatly. I’ve made life-long friends and met countless thoughtful, kind, humble, and whip-smart people who have a deep passion for investing and knowledge. The Motley Fool’s online forums and the people in Kairos have helped me become a better human being and investor over the years.   

I’ve also noticed – in these group interactions – that the more I’m willing to give, the more I receive. Giving unconditionally and sincerely without expecting anything in return, paradoxically, results in us having more. Giving is a superpower. 

Lesson 16: Be honest with myself about what I don’t know

When we taste success in the markets, it’s easy for ego to enter the picture. We may look into the mirror and proclaim: “I’m a special investor! I’ve been great at picking growth stocks – this knowledge must definitely translate to trading options, shorting commodities, and underwriting exotic derivatives. They, just like growth stocks, are all a part of finance, isn’t it?” 

This is where trouble comes. The entrance of ego is the seed of future failure. In the biography of Warren Buffett, The Snowball: Warren Buffett and the Business of Life, author Alice Schroeder shared this passage about Charlie Munger:

“[Munger] dread falling prey to what a Harvard Law School classmate of his had called “the Shoe Button Complex.”

“His father commuted daily with the same group of men,” Munger said. “One of them had managed to corner the market in shoe buttons – a really small market, but he had it all. He pontificated on every subject, all subjects imaginable. Cornering the market on shoe buttons made him an expert on everything. Warren and I have always sensed it would be a big mistake to behave that way.”

The Shoe Button Complex can be applied in a narrower sense to investing too. Just because I know something about the market does not mean I know everything. For example, a few years after I invested in Atwood Oceanics and National Oilwell Varco, I realised I was in over my head. I have no ability to predict commodity prices, but the business-health of the two companies depends on the price of oil. Since I came to the realisation, I have stayed away from additional commodity-related companies. In another instance, I know I can’t predict the movement of interest rates, so I’ve never made any investment decision that depended on interest rates as the main driver. 

Lesson 17: Be rationally optimistic

In Lesson 1, I showed that the world had lurched from one crisis to another over the past decade. And of course, we’re currently battling COVID-19 now. But I’m still optimistic about tomorrow. This is because one key thing I’ve learnt about humanity is that our progress has never happened smoothly. It took us only 66 years to go from the first demonstration of manned flight by the Wright brothers at Kitty Hawk to putting a man on the moon. But in between was World War II, a brutal battle across the globe from 1939 to 1945 that killed an estimated 66 million, according to National Geographic. 

This is how progress is made, through the broken pieces of the mess that Mother Nature and our own mistakes create. Morgan Housel has the best description of this form of rational optimism that I’ve come across: 

“A real optimist wakes up every morning knowing lots of stuff is broken, and more stuff is about to break.

Big stuff. Important stuff. Stuff that will make his life miserable. He’s 100% sure of it.

He starts his day knowing a chain of disappointments awaits him at work. Doomed projects. Products that will lose money. Coworkers quitting. He knows that he lives in an economy due for a recession, unemployment surely to rise. He invests his money in a stock market that will crash. Maybe soon. Maybe by a lot. This is his base case.

He reads the news with angst. It’s a fragile world. Every generation has been hit with a defining shock. Wars, recessions, political crises. He knows his generation is no different.

This is a real optimist. He’s an optimist because he knows all this stuff does not preclude eventual growth and improvement. The bad stuff is a necessary and normal path that things getting better over time rides on. Progress happens when people learn something new. And they learn the most, as a group, when stuff breaks. It’s essential.

So he expects the world around him to break all the time. But he knows – as a matter of faith – that if he can survive the day-to-day fractures, he’ll capture the up-and-to-the-right arc that learning and hard work produces over time.”

To me, investing in stocks is, at its core, the same as having faith in the long-term potential of humanity. There are 7.8 billion individuals in the world today, and the vast majority of us will wake up every morning wanting to improve the world and our own lot in life – this is ultimately what fuels the global economy and financial markets. Miscreants and Mother Nature will wreak havoc from time to time. But I have faith in the collective positivity of humanity. When there’s a mess, we can clean it up. This has been the story of our long history – and the key driver of the return my family’s portfolio has enjoyed immensely over the past 9 years, 7 months, and 6 days.

My dear portfolio, goodbye.

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Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. I, the author, will be making sell-trades on the stocks mentioned in this article over the coming weeks.

Singapore Exchange’s regulatory arm, SGX RegCo, announced recently that it has established a working group of industry professionals and investors to review the regulatory framework for Singapore’s retail bonds market.

I do not have any power to influence the decisions of the working group, but I was inspired to pen my thoughts on the matter yesterday after meeting a friend of mine who’s a veteran in Singapore’s financial journalism scene.

More specifically, my thoughts are on (1) the type of information that I think is important to be presented to investors if a company is going to issue a retail bond, and (2) the format of how the information is to be presented. Chinese New Year is just around the corner, so my early CNY wish is for my thoughts to reach the eyes of the powers that be for consideration.

Setting the stage 

During our meeting, my journalist friend (he’s retired now) reminded me that Singapore has an aging population, which would likely boost the demand for retail bonds in the years ahead. This makes the issue of improving the regulatory framework for retail bonds in Singapore a critical matter to me.

Hyflux’s infamous collapse in 2018 affected 34,000 individual investors who held its preference shares and/or perpetual securities – and I’m hurt when I hear of such stories. Preference shares and perpetual securities are not technically retail bonds. But the three types of financial instruments are close enough in substance to be considered the same thing for the purpose of my discussion.

There’s no way to conduct a counterfactual experiment. But I think it’s reasonable to believe that many of the affected-investors in the Hyflux case could have made better decisions if they had access to pertinent information about the company that they can easily understand.

Right now, there are product highlight sheets that accompany retail bonds in Singapore: Here’s an example for Hyflux for its 6% perpetual securities that were issued in May 2016. But there is information that is lacking in the sheets, and it’s not easy for layman-investors to make sense of what’s provided. 

With this background, let me get into the meat of this article. 

Type of information to be presented to investors

If a company is going to issue a retail bond, I think there are a few important pieces of information that should be presented to investors. The purpose of the information is to allow investors to make informed decisions on the risk they are taking, without them having to conduct tedious information-gathering.

These information are: 

1. Can the bond be redeemed? Who gets to call the shots, and at what terms?
2. The dollar-amount in annual interest as well as total interest that the company in question has to pay for its retail bond issue.
3. The operating cash flow of the company, and capital expenditures, over the past five years. 
4. The amount of debt, cash, and equity the company currently has, and the pro-forma amount of debt, cash, and equity the company will have after its retail bond issue.
5. Is the bond issue underwritten by the banks that are selling the bond?
6. What is the money raised by the issue of the retail bond used for?

I note that the information above is meant for companies that are not banks or real estate investment trusts (REITs). Tweaks will have to be made for the banks and REITs but I believe my list above is a good place to start. 

Format of information-presentation

I think that the information I mentioned above will be most useful for investors if they are presented all in one page, and are accompanied by descriptions of the information, and their significance, written in layman’s terms. Here are my suggestions.

For “Can the retail bond be redeemed? Who gets to call the shots, and at what terms?”

• Description: A retail bond that can be redeemed means that the retail bond issuer (the company in question) is required to pay the retail bond holder (you) the full amount of the retail bond. Sometimes, the company in question gets to determine when to redeem the retail bond; sometimes, you get to determine when the retail bond is redeemed. 
• The significance: The timing of when you can get your capital back is affected by (1) whether the retail bond can be redeemed; and (2) who gets to determine when the retail bond is redeemed.

For “The dollar-amount in annual interest as well as total interest that the company in question has to pay for its retail bond issue.”

• Description: A company has to pay interest on the retail bond that it is issuing – and that interest is paid with cash. 
• The significance: If you know how much interest the company is paying each year, and in total, for a retail bond issue, you can better understand its ability to pay the interest.

For “The operating cash flow of the company, and capital expenditures, over the past five years.”

• Description: The operating cash flow of a company is the actual cash that is produced by its businesses. Capital expenditures are the cash that a company needs to maintain its businesses in their current states. Operating cash flow less capital expenditures, is known as free cash flow.
• The significance: There are no guarantees, but knowing the long-term history of a company’s operating cash flow and free cash flow can give you a gauge on the company’s ability to produce cash in the future. The level of a company’s operating cash flow and free cash flow is important, because a company needs to pay the interest on its retail bond, as well as repay its retail bond, using cash. If operating cash flow is low, the company will find it tough to service its retail bond. If operating cash flow is high but free cash flow is low, it is also tough for a company to service its retail bond; a reduction in capital expenditure can increase free cash flow, but it will hurt the company’s ability to generate operating cash flow in the future. 

For “The amount of debt, cash, and equity the company currently has, and the pro-forma amount of debt, cash, and equity the company will have after its retail bond issue.”

• Description: A company has cash, properties, equipment, software etc. These are collectively known as its assets. A company also has bank loans, bonds that it has issued, money that it owes suppliers etc. These are collectively known as its liabilities. The equity of a company is simply is assets minus liabilities. The term “pro-forma” in this case is used to refer to how a company’s finances will look like after it issues its retail bond, based on the latest available audited information. 
• The significance: If a company has good financial health, it is in a stronger position to repay and service its retail bond. To gauge a company’s financial health, you can look at two things: Firstly, its cash levels relative to its debt (the more cash, the better); and secondly, the ratio of its debt to its equity (the lower the ratio, the better). Debt in this case, is the summation of a company’s bank loans and other bonds.

For “Is the retail bond issue underwritten by the banks that are selling the bond?”

• Description: A retail bond that is issued by a company may be underwritten or not underwritten. An underwritten retail bond is a bond that is purchased by a bank that is then resold to you. 
• The significance: If you and other investors do not want to purchase an underwritten retail bond, the bank involved ends up holding it. So if a bank underwrites a retail bond, it typically means that it has more confidence in the bond as compared to one where it does not underwrite. 

For “What is the money raised by the issue of the retail bond used for?”

• Description: The company in question is issuing a retail bond to raise money for specific purposes.
• The significance: A company can issue a retail bond to raise money for many reasons. There is one particular reason that typically tells you you’re taking on higher risk: The company is issuing a retail bond to repay a previous loan or bond that has a lower interest rate.

The Good Investors’ conclusion

Ultimately, individual investors need to be responsible for their own actions – it’s not the regulator’s responsibility to offer total protection. But in the case of Singapore’s retail bonds market, I think there is still scope for significant improvements to be made in investor-education and other aspects. 

My suggestions above are meant to highlight the most crucial information about a company that is issuing a retail bond so that individual investors can quickly gain a good grasp of the level of risk they are taking on.

The working group is expected to present its recommendations to SGX RegCo sometime in the middle of this year. A public consultation will also “likely take place by the end of the year.” May the recommendations put forth by the working group lead to investors in Singapore having a better experience in the retail bonds market!

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.