My Investment Record (13) - 30th Sept 2014

Market Overview

KLCI continue its downward trend this month, dropping around 20 points (1%) probably due to large outflow of foreign capital. As expectation on US Fed to raise interest rate earlier next year growing high, foreign capital are retreating from emerging market to go back US in anticipation of stronger dollar and better return in US. News of China economy slowing down may further exaggerate the situation. 

On local front, Bank Negara didn't raise OPR during latest MPC meeting (here). This is a good news to the market as higher OPR will make KLSE stocks look more overpriced and unattractive as investment. Q3 GDP data expected to be released around mid of November shall give us more clue on which direction Malaysia economy is heading. Until then i don't think Bank Negara will raise the OPR during next MPC meeting at 6th November. 

Current Return and performance

The estimated holding period return for KLCI in the past period (1st September 2014 - 30th  September 2014) is -0.80% (with dividend included). Holding Period return for my portfolio, is 0.44%. Total holding period return for my portfolio since the inception is 24.61%, annualized to be 11.14%, this is the third time it passed KLCI total return of 20.35% (annualized, 9.30%). 

The outperform can be attributed to a single stock - Mega First Corporation Berhad (MFCB, 3069) probably due to the latest annoucement that one of its project at Laos just got an extension of term. (source) 

Trading Activities

i. Addition of Symphony Life (1538). The stock is trading at nearly half of its NAV now. Although recent news that their township development at Sungai Long been holding back due to potential land acquisition by Selangor government, future pipeline of project remain strong (see here). This make its stock looks attractive with P/E around 6 to 7. 

ii. Addition of Public Bank (1295). and
iii. Addition of CIMB (1023)

Due to recent plunge in KLCI affected by external environment as outline in market overview, the share prices for this blue chips took a small dip. I am cautious that i may not adding the stocks at their lowest point in near visible term, the sole reason for investing was purely based on the following market view. 

Although KLCI looks a bit overpriced now, my bet is that while KLCI will continue suffer some correction (probably fall back to 1800-1820 level), but will remain overpriced for next two to three years. Hence, without knowing which stocks will perform in the future, holding a basket of stocks which i aim to build into my portfolio in long term will be a safer bet. 

Besides, contrast with other close-end funds which will not see any addition of capital, I have the ability to add capital (cash) when the opportunity came via two methods. 

1)  I am depositing my saved salary into the portfolio every month. My portfolio cash position will grow everymonth if i dont buy any new stocks. 

2) I have the ability to draw down quite a sum of cash (via personal loan, EPF and some other stable investment) when necessary. 

Hence, there is no need for me to hoard cash in anticipating of a crash like Icapital do.

A more prudent approach will be stop buying (or start selling small) when market is at near term high, and start buying when market is at near term low, keeping cash position in range of 5% - 25% of total portfolio value. 

However, Investors with less way of raising capital when time required should take a more conservative approach.  

Dividend Re-investment Scheme (DRS), is it worth it?

I'm not sure which company start introducing the Dividend Re-investment Scheme (DRS), but it had been popular by most of the banks in Malaysia when paying out the dividend to their shareholder. In short, a DRS allow shareholder to re-invest part of the dividend received into new share of particular company, often at a discount below the market price for existing share of the company. Banks like to do this to increase their capital to comply with future regulatory requirement, while keeping their promise with shareholder on stable dividend payout. Shareholder will then need to make a choice on whether he will like to keep the dividend as cash or re-invest as per term and condition of DRS. 

There are potentially three situations the shareholders will be facing:

Situation 1 : The shareholder is in need of cash

Situation 2 : The shareholder is not in need of cash, and the price for DRS is below the current Net Asset Value (NAV) per share. 

Situation 3 : The shareholder is not in need of cash, and the price for DRS is above the current Net Asset Value (NAV) per share. 

For situation 1, since the shareholder need cash, there is really no choice but to forgo the DRS option. 

For situation 2, the advice is to always re-invest. This is because if you don't re-invest and others do, the NAV per share of your original share will be decrease due to diluting effect, and you loose the NAV without reason. To illustrate, for a company with 100,000,000 shares outstanding and NAV per share of RM 10, if the company decide to give dividend of RM 1 and DRS price is RM 5, a total of 20,000,000 shares will be issued. The NAV after DRS will be around RM 8.33. Now , if  you choose to keep dividend as cash instead of going for DRS, your total asset will be RM 8.33 + RM 1.00 = RM 9.33, compared with RM 8.33*1.2 = RM 10 that you have. A loss of RM 0.67 per share!

For situation 3, it is a bit complicated. 

To summarize, even though your NAV per share will increase, because of the diluting effect of new share issuance, your share on the company future earnings will be decrease. Further more, a company with market price higher than NAV usually has high Return on Equity (ROE), thus, the benefit of keeping cash (and invest elsewhere) need to compare with the loss in opportunity of additional investment of the company. There will be a rate of return of other investment that make the two choices equal which serve as an determining benchmark. That if the shareholder is optimistic of getting return above benchmark, he shall keep the cash from dividend and invest elsewhere, but if he is pessimistic of getting return below the benchmark, he shall opt for the DRS. 

Which lead to the question, how do we calculate this reference benchmark?

Let use an example to see. A company has the following characteristic

Current market price : RM 11

DRS price : RM 10

Earning per Share (EPS) = Dividend declare : RM 1 (thus a person holding 10 shares will get 1 share if opt for DRS)

Current shares outstanding, 100,000,000 shares

NAV (before/immediately after dividend) : RM 6/ RM 5. 

The NAV after DRS will be RM 5.4545, total number of shares will be 110,000,000, if all dividend reinvested in DRS. 

Now , regarding the potential change to share of future earning, there is 4 cases. In all cases below we assume the shareholder had 10,000 shares in the company. 

Cases one, regardless of the total capital employed, the total future earning for the company remain constant. 

This mean, the total earning next year will still be RM 100,000,000. 

But as total number of share had increased to 110,000,000. 

EPS will dilute to RM 0.909. 

If you opt for keeping dividend as cash, your share of company's earning will amount to RM0.909 * 10,000 shares = RM 9,090. 

If you opt for DRS, your share of company's earning will amount to RM0.909 * (10,000+ 1,000) shares = RM 10,000. 

The difference of RM 910, is what you required to earn with the dividend hold as cash. As the amount of dividend hold as cash is RM 10,000, the equivalent rate of return that make two options equal will be 9.1%. This mean that, if you confident that you can earn rate of return more than 9.1% in other place, you shall keep the dividend as cash (and invest elsewhere), else, you shall opt for DRS.

(one might also notice that the difference is due to additional shares invested X new EPS. )

Case two, regardless of the total capital employed, the Return on Equity (ROE) for the company remain constant. 

This mean, if the ROE for this year is 20% (EPS/Capital employed the year before)

The next year ROE will still be 20%. 

The difference between keep as cash and opt for DRS will then be 20% * RM 5.4545 * 1,000 shares = RM 1091. 

The equivalent rate of return that make two options equal will be RM 1,091/RM 10,000 = 10.91%. 

Case three, regardless of the total capital employed, the Return on Equity (ROE) for the company remain constant, but the Equity included tangible and intangible asset, and the amount of intangible asset remain the same before/after the DRS.

Tangible asset means the NAV that we can measured. 

Intangible asset usually can only be estimated and consisted of the skill of employees in the organization, the current marketing and distribution network, and also the value of the brand name. 

As the total amount of intangible asset assume to remain constant, but total outstanding shares increased after DRS, the intangible asset per share will decrease. Table below illustrate the cases with different amount of total intangible asset, and their resulted equivalent return requirement. For the trend, one can safely say that as long as the total intangible asset remain constant, the equivalent return required will range from 9.10 % (case where infinite intangible asset that change in NAV no longer relevant) to 10.91% (case where zero intangible asset that change in NAV will be dominant). 

Case four, the ROE for capital employed is not constant, and it will increase/decrease after DRS. 

In this case, since we already know the new NAV per share (equity) and additional number of shares invested (1,000), we just need to estimate the new ROE and multiply by new shares and equity per share. 

Conclusion?

We take Maybank (1155) recent DRS for example. (all data taken from bursa website, Maybank June quarterly financial statement, here)

Total number of shares = 9,117,393,000

NAV per share (before/after dividend) = RM 5.3653/RM 5.1253
ROE(annualized) = 14.67%
EPS (annualized) = RM 0.735
Dividend declared = RM 0.24
Electable portion of dividend for DRS = RM 0.20
Share price during ex-date = RM 9.88
DRS price for new share = RM 9.30
Total new shares if all opt for DRS = 196,072,968
New NAV per share ( if all opt for DRS) = RM 5.213

Assuming one shareholder holding 10,000 Maybank shares. The equivalent rate of return, for constant return case to constant ROE case, are shown in table below

This mean that, if you are confidence in getting rate of return higher than 8.23% in other investment, you should keep the Maybank dividend as cash. Else, elect for the DRS. 

Now, one would question what happen to the discount you receive by invest in DRS price lower than market price. Well, if you choose to invest in long term, the discount doesn't really matter as the ultimate price of maybank share will be determined by its EPS in the future and rate of return required by the market. 

There is one other option, to opt for DRS, then immediately sell the new shares obtain under DRS in higher market price to reap the price difference (RM 0.58 per new share). However, due to minimum selling lot restriction, one need to have at least 4,650 Maybank shares to enjoy the instant profit. The commission fee will likely reduce the profit further by about RM 12 (estimated commission fee incurred) if you sell 100 shares. But it is still profitable, and this explain why after the DRS period, large institution investor like Employee Pension Fund (EPF) will have immediate selling activities. 

How is ICAPITAL BIZ (5108) Performing?

The performance of ICAPITAL BIZ (the close end fund managed by Tan Teng Boo) had been lacklustre for the past three years, with compound rate of return averaging of 4.03% (calculated from their annual reports) compared to KLCI return of 9.53% (assume dividend yield of 3.2%). Its annualized return since inception in 19th October 2005 till 31st May 2014 remain impressive at 14.19%, this is significantly higher than KLCI annualized index return of 8.72% for the same period, and still higher than KLCI annualized total return of 11.92% for the same period (Total return = index return + dividend yield of KLCI stocks, average to be around 3.2% last year). 

Table 1: ICAPITAL BIZ annualized return compared with FBMKLCI 

(source : ICAPITAL BIZ annual report, here)

One of the investor blogger before me, AhYap had written some articles regarding ICAPITAL BIZ back in 2007 (here) and 2010 (here). I shall just continue on. 

The obvious reason why ICAPITAL BIZ's performance is lagging behind the benchmark (KLCI) for the past three years is their high level of Fund's Cash level. Mr. Tan and his management had been defending themselves with the following statement:

" What can the cash holdings potentially do to your Fund? Should the KLCI fall by 20%, the NAV of icapital.biz Berhad would drop only 9%, due to its current 55% cash holding. If the KLCI plunges 50%, its NAV would fall only 22.7%. This is the protection from its cash holdings. " 

Well, all i can say is the readers need to be aware that the reverse is also true. Cash holdings will give protection when market is falling, but cash market will hurt you also when market is rising. shall KLCI rise by 20%, the NAV of icapital biz will rise only by 9% due to its current 55% cash holding. Mr. Tan and his management had gone on with an illustration on how can they profit: 

"Table 4 below shows a scenario where we assume that the KLCI and the equity portfolio plunge equally by 50%. Again this example is merely for illustration purposes and is in no way a forecast or projection of future returns. Due to the cash holdings, the NAV drops only 22.7%...In such a situation, the cash assets will be deployed. Assuming an annual compound return of 15%, the NAV in year 6 will be 55% higher than in year 0 ..... In contrast, the KLCI will in year 6 be 16% lower than in year 0 (assuming its long-term past annual return of 11% for the KLCI)..."

Table 4: An illustration (source : ICAPITAL BIZ annual report, here)

Now, what if the reverse is happening, where instead of having a crash, KLCI continue its rising trend on 9.5% annualized total return as per past three years, and ICAPITAL BIZ continue its performance of 4% annualized total return as per past three years? Following table illustrates what will happen, where the investor sticking with KLCI will earn 30% more compared with investing with ICAPITAL BIZ.

The conclusion?

Mr. Tan and his management are currently relying on two skills to outperform the benchmark (KLCI):

i. Their ability to pick the stocks that will outperform market (stock picking skill)

ii. Their ability to time the market in order to buy low sell high (market timing skill). 

ICAPITAL BIZ current bid is that market will crash soon, which they act accordingly by hoarding more cash. It is too earlier to say whether their prediction/bid is correct or wrong, but here are my two cents:

i. History in stock market index movement tends to repeat itself but with less and less fluctuation in magnitude term. The lesser fluactuation (from index peak point to next lowest point during crash) is due to a) learned authority and regulator (the government and bank negara) in stabilizing the market during crash course, and b) more intelligent investors (especially institution investors like EPF and mutual funds) which will sell when they perceive the market is overprice, and start buying when the market is oversold. This means that, it is unlikely to see KLCI following crash course in 1998 where the index evaporated 76.7% from 1126.83 @ 3rd June 1997 to 262.7 @ 1st September 1998, It is also less likely to see the crash course in 2008 where the index evaporated 45% from 1516.22 @ 11th January 2008 to 835.17 @ 9th December 2008 (source)

ii. No news or major economic indicators indicating that Malaysia economy is going to hard-landing/market is going to crash soon. In 1998 we had the Asian Financial Crisis sparked by currency crisis of south-east asia countries, in 2008 we had the US. Housing Crash. As i predicted before:

"  It took at least three years for the sign of crash to be seen after US Fed raised policy rate starting June 2004. And we are still waiting for Fed to make its first move in raising the policy rate now, which will directly increase the borrowing costs and start slowing the economy (and housing market) down." 

iii. The market is definitely overprice now but the degree of overpricing still not reach dangerous level. Hoarding cash is a prudent move, but holding too much cash like 55% level, will hurt the performance of your portfolio. 

RM5,900 average household income?

One would certainly doubt the figure when the federal minister's claim that malaysian household's make an average RM5900 per month. There is one article who summarize well how the figure derived from and what does it mean here. To summarize short:

- Income not only mean wages and salary, but include investment income from properties, stocks, and probably EPF. 

- "mean" figure means rich people who earn many money will tend to distorted the figure. " median" income is a more realistic assessment. 

- some of the income are imputed, means income are counted even though you consuming self-produced goods and services. For example, if you living on your own house, the survey will assume you will receive an income (rent) from your house with as the amount you will received if rent it out to others in the rental market. If you cook your own meal, the survey will assume you received income (from yourself) on the cooking services that you provided.

What should be interesting, is how the income distribution go, and what can we do about it. 

For example, if you read p29 from 2012 household income survey (here), it can be seen that Malaysia's Gini Index according to household income is about 0.431. This implicates a high income inequality distribution taking place in Malaysia. The sources of the income inequality could be from different in education received, as indicate in table below from Malaysia Salaries & Wages Survey Report (here). It can be seen from the table that, although degree holder generally earn higher salaries and wages (mean = RM4571) from diploma holder (mean RM 2839) and below (mean RM 1721 for SPM holder to RM992 for no cert). Only 12% of current workforce hold a degree. 

Table: Average salaries and wages according to education level , Source: Malaysia Salaries and Wages Survey Report

Few measures i believe can help to ease the inequality in income distribution.

Measures 1 : Increase the coverage of quality higher education. The chances of getting a higher education in Malaysia is increasing thanks to more public universities built, more private college and universities allowed to open, and PTPTN loan. but the quality of education received may not keeping pace. (see here and here for story of graduates jobless or in job mismatch with education received)

Measures 2 :  Restricting the number of foreign workers at low skill category, both legal and illegal. 

As salaries and wages in the market is determined largely by supply and demand, large influx of foreign workers in low skill category will continue suppress the salaries of the locals in that particular category. Thus, restricting their numbers, thus altering the demand and supply in the job market, will be the most effective way to increase the salaries and wages of low income workers compared to minimum wages policy. There are only two problems, first, the small and medium enterprises (and plantations) who heavily relied on cheap labours to remain competitive will not be happy about this, Second, as large number of foreigners had been granted citizenship in Sabah, the supply of low skill workers in job market may still higher than demand, thus keep suppressing wages in this category. 

Measures 3 :  Easing the income inequality through tax and transfer system. More specifically, increase the aid for low income group under BR1M, and fund the increase by taxing the rich. Few of the new taxes targeting rich people that can be introduced include, 

i. Capital Gain Tax

ii. Real property gain tax for second home owned

iii. Estate tax and gift tax