Money for Nothing?

On Thursday Dagens Nyheter reported that Roburs vd Tomas Hedbrg had admitted that their most popular stock funds Allemansfonden and Kapitalinvest have probably not tried hard enough to beat their respective indexes (here).

He is quoted as saying that the funds had copied the indexes too closely resulting in just beating them just the once in the past 10 years. To fail to beat an index in itself is no big deal, plenty of others have tried and failed, but to not even try whilst charging a 1.42% fee is a complete failure to deliver value for its customers.

Both funds currently hold 70 billion sek in assets and pull in 1bn in fees avery year for funds that should be charging 0.4% as 'index' funds. That's 700m sek extra for doing nothing extra for their customers, a 175% markup! It's very easy too be cynical here and suspect they were treating these funds as easy money cash cows.

Why have so many people chosen these funds? Perhaps it's a lack of knowledge on their part and/or poor advice. The latter is more disturbing. Surely it goes against exactly what the professional advice should be telling their clients, 'avoid closet index funds'!

The following is a graph showing the funds performances over the past 10 years compared to AMF's World Share fund. All three hold a mixture of Swedish and global stocks, predominantly US and European.

AMF's is the clear winner over the past 3, 5 and 10 years (the Sharper ratio is also superior). The main difference? A far cheaper 0.4% fee. Interestingly in their material AMF claim this fund is actively managed based on low valuations and fundamentals.

The fund has a benchmarks that is 60% OMXSBGI (Swedish index) and 40% FTSE World Index.
Its relative performance is shown below, the benchmark normally wins but it's close; yearly compounded at 8.83% v 9.96%. Even with this better performing fund there is some room for improvement.

The take home message is fees really count. Some actively managed funds will be able to beat the indexes but they are few and far between. Without knowing specifically what strategies are being used by these funds it is unlikely you will find a future winner.

The absolute worst you can do is overpay for a fund that is no different to a passive fund. Know what the comparable index fund is charging and then try to find out what potential value the active fund is offering for the extra fees.

As an end note, Robur's admittenace of their mistakes is to be commended and they now say their two funds are being managed more actively in an effort to beat their index.

The question though investors should still be asking themselves is, will these funds be able to do so when so many others have failed and by a margin that will compensate for the high fee. Only time will tell!

Selling Volatility As An Asset Class

I was thinking the other day about non-correlating asset classes in order to decrease portfolio risk and even improve return, when I got curious as to whether being long volatility could be used in such a way. My theory being volatility increases in down markets when fear takes hold, which would be opposite to the market trend and would hence add diversification (or at least a hedge) to a portfolio.

My first assumption was that it would be the implementation of such a strategy that would be the most difficult part as options are a wasting asset, decreasing in value with time, and the VIX ETF is not suitable for longterm hedging (see here).

This led me to the following paper 'VIX Futures and Options:A Case Study of Portfolio Diversification During the 2008 Financial Crisis' (here). Interestingly the author did find being long volatility, via either VIX futures or 25% out-of-the.money calls,  did improve returns sometimes even with lower volatility, when added to as a 1% or 3% allocation to different portfolios.

'So what's the catch?' you are probably asking. Well the study covers a particular time period between March 2006 and Dec 2008, when there was a significant downturn and volatility spiked upwards. No strategy is suggested unfortunately in how to implement this long volatility asset portfolio allocation in preparation of such a bear market.

This however is where it gets interesting as the author refers to previous studies that suggest the following

1. Long volatility is associated with a negative risk premium, therefore over extended periods of time, long volatility positions tend to underperform the market.
2. Being short volatility should be considered an asset class and option writing strategies find excess risk-adjusted returns for short volatility positions.

Further investigation then led me to another article, this time by Blackrock called 'VIX your portfolio: Selling volatility to improve performance' (here). Here the author looks into different ways at selling volatility on the S&P500 index and shows how such a strategy would perform as a stand alone or in a diversified portfolio.

Selling volatility should capture a positive risk premium as it is said to the the same as selling insurance. Investors buy this insurance to protect their portfolios from down markets when volatility rises. The seller of this insurance (read volatility) bears the risk for protecting these portfolios so is paid a risk premium over the longterm.

Below is a graph showing the implied end of month volatility in the S&P500 from 1990 and its comparison with the realised end of month volatility. The difference is usually positive, hence the risk premium sellers receive. It is worth noting the exceptions in bear markets, such as in 2009, a time period which was covered in the first article. 

Next is a graph showing the performance of the S&P500 compared to the CBOE S&P500 PutWrite Index, a hypothetical portfolio where an at-the-money index put is sold every month. The performance details are not shown here (but can be easily found in the paper) but selling volatility in this way resulted in a higher return than the index, with lower volatility and a smaller maximum drawdown.

There are also some paragraphs on 'Avoiding blowups' and 'Risk management' that are definitely worth reading. Selling puts provides an investor with a defined and limited upside but is combined with a potential unlimited loss!

The nature of this type of investing means there are long periods of small steady wins and limited drawdowns punctuated with sudden periodic large losses. Selling out-of-the-money puts with high leverage is a recipe for disaster when the next black swan comes along. 

Selling puts for income is a strategy I have added to my portfolio over the years. I like receiving the premium and using time decay to my advantage, so it was very interesting to read that in the longterm such a strategy has the odds stacked in its favour.  

As always do not invest in anything you do not fully understand. It takes a lot of reading to understand how options are structured, how they work, the risks involved and all the possible strategies in using them.

A simple two fund portfolio

Before I get into the original purpose of this blog entry I would firstly like to highly recommend this article by Fidelity  It describes the importance of diversification and how the addition non-correlating assets can lower the overall risk of a portfolio.

Some important messages include:

1. A simple diversified portfolio of stocks and bonds would have had a smaller draw down than that of just stocks during the financial crisis of 2008.
2. The recovery of the diversified portfolio from 2009 to 2013 is slightly lower but its overall performance is still superior to the 100% stock portfolio.
3. Correlations between assets classes did increase during the financial crisis but importantly they didn't become fully correlated. Diversification still worked!
4. To be able to fully benefit from diversification investors would have had to stick to the asset allocation throughout the bear market instead of being tempted to shift to lower risk assets and then missing the subsequent recovery in stocks.

The following is a suggestion for a very simple diversified portfolio, one fund in bonds and another in stocks. The primary goal is to maximise diversification for minimum cost. We ideally want global exposure, get it as cheap as possible, and exploit the low correlation between binds and stocks.

Starting with stocks we can find:

SPP Aktiefond global, 0.3% fee

AMF Aktiefond global, 0.4% fee

Both hold hundreds of shares from around the role predominantly in the USA, Europe and Japan. If there is any weakness it's that the emerging markets and Asia get a bit less than 10% exposure. Performances over the past 5 years are about the same at roughly 50%.

The only difference is the SPP fund does not invest in companies considered to be unethical such as those involved with weapons and tobacco. So it's up to the investor if this is important to: them or not when choosing between the two.

The next part is the bond component:

Öhman obligationsfond, 0.15% fee

AMF Räntefond Mix, 0.3% fee

Öhmans fund is the cheapest bond fund which invests in Swedish sovereign debt. However, I like the look of AMF's fund which invests in government bonds from not only Sweden but also the rest of Europe and USA. For a slightly higher fee one gets far more diversification. 

The allocation of the two funds depends on ones tolerance to risk; typically more bonds means less volatility and smaller drawdowns. This also means with age the older you are more a higher bond allocation is recommended to lock in gains and reduce any potential loses as retirement approaches.

It will be interesting to see how this type of strategy will work in the future as we are currently in a very low interest rate environment, bonds prices are very high and we have just come through a 30 year bond bull market. The expectation going forward is rising interest rates and big losses for those with investments in bonds.

However, for the moment, the standard portfolio is a 60/40 stock & bond mix but I'm a more of a stock fan so prefer more of a 70/30 allocation.  So here it is

70% AMF Global stock fund

30% AMF Mix bond fund

A simple two fund portfolio that achieves global diversification across two asset class at a relatively low fee of 0.37%. Both allow very small monthly investments, as low as 50 SEK, and being funds no trading fees would be incurred, such as with ETF's.

A possible 50% crash: What should I do?

Business insider recently released an article arguing the the case for the increasing likelihood of a crash, a big one in the range of 40%-55%. To be fair the article is quite balanced in that the author doesn't scream 'sell! sell!' and clearly states he is still invested in stocks but it did get me thinking.

I first became really interested in investing strategies soon after the financial crisis, which pretty much means I've only really experienced as a 'conscious investor' the wave of a bull market and never the white knuckle ride of seeing my investments cut in half by the panic of a possible world wide depression.

What has been fascinating though is during this time is the constant flow of end of the word predictions, end of the dollar, end of the euro, end of sovereign debt, end of USA, end of the european union, buy gold, buy silver, only to see the stock market just keep on going up, up, up!

It can be completely convincing and in fact compelling to read an article with deep analysis and flourishes of descriptive narration on how exactly the modern economy and its fiat currency will come to and end. The problem is all these predictions, despite their seemingly logical arguments have proven to be wrong!

The problem is with enough predictions going around combined with enough time someone somewhere will eventually look like a master predictor! As the staying goes 'even a broken clock is correct twice a day', although I prefer 'even a blind chicken finds a kernel of corn every once in a while'. Bear markets come and go, keep on predicting one long enough and you will eventually be proven correct.

Does it mean it will never happen, no of course not. It just means any prediction, bullish or bearish, is taken by my good self with a huge lorry load of salt! I read them, understand them, but then just file them in the 'could happen' category. I do not under any circumstance keep changes my investment strategies based on what I read. 

So back to this prediction that is currently taking hold especially with those with a bearish bent. Apparently valuations have only ever been this high twice before in history. That's right, twice, thats barely a correlation let alone a causation of severe bear markets.

Yes, there could be a 50% pull back from here, history shows they are rare but do happen. Should I though really care? When I care I mean, should I pull out all my money, change tactics, panic buy gold etc. Well I'm certainly not going to pull all my money out. Going to cash could easily mean I end up watching the market go to new highs whilst I sit on the sidelines waiting for Mr Market to deliver the big pull back that had been predicted.

(At this point it is important to say I have the benefit of not retiring in the next couple of years. For near retirees an upcoming bear market that could half your pension would be very worrying indeed).

Fact is bear market or not I will continue every month to add to my diversified portfolio of stocks and bonds in different countries across the globe. That will not change. On top of that with a 50% drop I will actually be scooping up twice as many shares for my future pension. 

Two years ago I was still adding to my European stocks when it looked like Greece would default and the whole union would fall apart. I was still adding to my emerging market stocks earlier this year when the supposed FED taper caused a pull back and the chatter was then about the end of the emerging market bubble.

This is the magic of passive index investing. Set up the monthly payments on automatic and let it run year after year, slowly accumulating stocks, ignoring the ups and downs of what might happen next.

Investors can even add a simple in/out trigger based on the 200-day moving average of each of the indices they are following in their portfolio. Simple. This way when the bears start shouting 'I told you so, look, look!' you can remain calm and simply sell and go to cash when prices fall though the moving average, then get back when prices move higher again above the moving average.

The markets are a complex ecosystem of many factors that do not always produce the same events and outcomes. Step away from the predictions, focus on putting together a sound investment plan and hold the mindset that no one really knows what will happen from here on.

Valuation: TeliaSonera

Another day, another Q3 report, it's that time of year! Today it was the turn of the telecommunications giant and large cap stock TeliaSonera. It has been well received by the market, with the share price up 3.8% for the day.

That's a big move for this company that doesn't usually move so much. That makes it boring and potentially interesting although it is a very widely held stock by Swedish private investors. This for me is a small warning flag and probably an outcome of searching for stable yield in this low interest rate environment.

It was a slightly odd report in that both sales and net income were down for the first 9 months of this year compared with 2012. Not only that organic growth is flat. However, the report was better than expected hence the stocks rise.

Perhaps that is good news. Expectations are low for this company, so there is room for surprise on upside. Anyway lets take a look at some numbers to understand what we would get for our money when investing in Telia.

P/E 10.8, P/B 2.1 and dividend yield 5.75%. Nothing untoward here, pretty much standard for such a company. 'Owner earnings' (as described in my SKF post) comes to 24459 msek, that's a lot of money. That gives a 'cash yield' of 10% (dividing by market cap) which is good, but how confident can we be with future earnings?

I plumped for a mediocre growth rate of 2% the coming years and discounted the potential cash flows at 9%. This gave a value of 64kr with a 25% margin of safety and 43kr with a 50% margin; with a current share price of 51.5kr this looks favourable. 

The question still remains if there is a future catalyst for Telia and whether it can acheive the longterm profitability desired. If they can turn around, then I'm certain there is a lot of upside potential in this stock.

 

Valuation: SKF

Yesterday the first of the large cap big guns, SKF, released its Q3 report. The company is a leading global supplier of products, solutions and services within rolling bearings, seals, mechatronics, services and lubrication systems. Because of its global sales and business to various industries it is also seen as a bell weather for the Swedish and global economy.

The report failed to meet expectations causing the share price to drop around 7% from 184kr. It has recovered slightly with the latest US budget news and lies now at 173kr. Expectations were probably too high with the share price up 20% this year before the report came out.

Disappointing quarterly reports can provide buying opportunities, yet the question we must ask is whether a cheaper price also means good or better value. I will attempt to answer his question buy going through some numbers.

Firstly with a P/E 19.7, P/B 3.5 and ROE 18.2% it certainly isn't a classic 'value stock' and is priced for growth. How much growth and at what price is the next question. To answer this I have calculated an 'owner earnings' for the past 5 years. These earnings can be viewed as the cash generated by the company which could be returned shareholders, sometimes also referred to as a 'potential dividend'.

As it is SKF pays an reasonable dividend of 3.2%, which is 62% of earnings, the rest is kept by the company. We can try to put a value on the company by determining a current value of these potential future cash flows.

Anyway, 'owner earnings' are calculated as follows 

Owner earnings = Net income + Depreciation & Amoritisation - Capital Expenditures

As SKF is an industrial related company, I took an average of the past 5 years to capture the recession of 2009 and get a cyclically adjusted cash flow of 3896 msek. At this point I extrapolated the growth of this cash flow 20 years into the future, a lot of assumptions of course built in there!

I was fairly generous (I believe so anyway!) and gave SKF an earnings growth of 7% for the next 5 years, then 5 % up to the final 5 years which was then reduced a modest 3%. Each of these projected yearly owner earnings were then discounted at 9% to a present value.

The sum of these cash flows were added to the book value of equity and divided by the number of shares to give a value per share of 174.8kr. Pretty much the current market price!

Admittedly I probably have been anchored by the market price and adjusted the inputs accordingly. However, we now have an understanding of what expectations are required to get a share price of 174kr. If you think they are fair or even overly cautious then SKF could be a buy at these levels.

Ideally a margin of safety should be included in the valuation, such as 25%, to cover for inevitable mistakes and give us room for error. Such a margin would suggest a buy price of 131kr.

They say patience is a virtue, especially for value investors, but with the current market strength and continuing bullish sentiment I will not be holding my breathe whilst waiting for another 25% decrease in SKF's share price! The hunt continues.

Daily Bitesize: There's more than one way to skin a cat

As the saying goes "There's more than one way to skin a cat", meaning there are always several ways of achieving a task and in the end you get the same outcome, a skinned cat!

Well the same seems to be true of buy-and-hold asset allocation. Meb Faber has taken several well known and mainstream portfolios, such as the classic 60/40 equity/bond asset allocation, and compared their performances from the early 70's here and here.

The outcome is quite surprising, to me anyway, as the returns are all very similar! It doesn't really seem to matter if you pick a portfolio that is fairly simple (e.g. 33% each of US equities, bonds and real estate) or somthing more complex like the El-Erian Portfolio (containing TIPS, commodities, special situations, private equity etc).

The message is clear, diversification works but don't over complicate it or pay too much.

How to beat the pros

Let's start by taking your favourite sport, it could be football, basketball or hockey. Imagine you could turn up to play right now in any competition and you would be instantly average in your ability and performance. Not only that, you would outperform most of your peers. No training or practice would be required just a willingness to turn up and play!

Each season there would be better players than yourself but as long as you played you would put in an average performance.. To your amusement over the years these stars would come and go but you would still be there year after year outplaying the vast majority of your competitors. Your longterm performance would be one of the best in the sport.

The odd thing is whenever you get bored and try to 'improve' your game to increase your performance you would actually become worse! You would make too many mistakes. Your skill is actually the discipline to accept you don't have that much talent and that your average ability will be highly rewarded over the longterm.

This very strange and unusual situation exists in the world of investing. By simply investing in passive index funds you can guarantee yourself an average performance and beat most active fund managers, see here and here for some examples of data.

At this point I have tried to find links to the counter arguement that active management is superior to investing in index funds. The best I could do is this. Any articles/papers/suggestions welcome!

This is not to say investing in a portfolio of index funds to capture the market return is easy. It's not. Avoiding behavioral mistakes will be your biggest challenge, especially in bear markets when you see the value of you investments going down the drain. Pulling your money out at the bottom of the market and waiting until later when it feels safe again will ruin your returns as you will miss a significant part of the recovery.

Because of the strong arguments in favour of passive investing a significant part of my investments are in broad portfolios of cheap index funds. I make some exceptions though when certain indexes are not available as funds in the Swedish market e.g. small cap and value stocks. In such cases I select the cheapest 'active' alternative.

What is interesting is that there are a multitude of  strategies that have been shown to beat stock indices (e.g there is a whole book on this 'What works on wall street') as they are fundamentally flawed in that they are market cap weighted. In fact any strategy in composing an index, including random, beats market cap weighting! link

One can make use of value, such as CAPE, P/E or P/B, size i.e, small cap or momentum to beat an index. Some approaches use even a combination, such as value and momentum e.g. here. I also invest in these type of 'active' strategies.

So why do fund managers fail to beat their benchmark indices. One explanation is that any over performance gets eaten up in fees. Another may be also that any strategy will have inevitable periods of underperformance during which the manager gets moved on or the fund is closed down.

Individual investors can exploit these disadvantages, yet still have their own psychology to contend with when underperforming the market for perhaps many years. Just take a look for example at value investing during the late 90's, which then rebounded link.

Valuation: NAXS Nordic Access Buyout Fund

Firstly thanks to @financeamir on Twitter for bringing this stock to my attention.

NAX is an interesting and unusual company that is traded on the Norden Small Cap index. It allows investors access into the Nordic buyout market via funds that are normally over subscribed and 'closed' to a broad set of investors.

Since the IPO in 2007 they have steadily increased the % of equity invested in private equity funds from 7 to 86%, with the rest being in cash. The rolling 12-months earning per share is 2.83kr with NAV (July 2013) of 40,53kr per share.

The shares price is up 22% the past 12 months but has been in a trading range since around July and currently lies at 38kr, P/E 13.4 and discount to NAV 6%.

If we want to get an idea of what a reasonable price is for this stock we need to get a sense of its value. Putting a value on the underlying assets could be a tricky business especially as we don't know all the companies held plus they are not publically traded.

A simpler way, which of course introduces caveats and assumptions, is to simplfy the company down to a dividend payer and just value those cash streams. The last dividend for this year was 0.4kr with an intention to payout 0.5kr In 2014.

That's a paltry yield of 1.31%, however the long term plan is to increase the payout to shareholders to between 50-75% of earnings (currently 17.6%).

Let's assume its earnings grow at a steady 5% every year whilst the dividends paid out increase every year from the current ratio to 70% in 6 years time. The dividends received are shown below.

YEAR  Dividend

2014      0.5

2015      0.9

2016     1.25

2017     1.64

2018     2.06

2019     2.53

In 2019 we will then value the stock as if it will increase its dividend at 5% for perpetuity as earning rise at the same rate giving a terminal value. We can then discount these future cash flows and the future value of the dividend paying stock to a present value using a discount rate of 10% (many ways of calculating this but I've gone for a nice round number).

YEAR  Present value

2014      0.46

2015      0.74

2016      0.94

2017     1.11

2018     1.28

2019     1.43. Terminal present value 18.5kr

Doing the maths we get a total value per share of 24.5sek, 35.5% below the current share price. Clearly the market values this stock differently but gives us an idea of what the dividend side of the business could be worth under this scebario.

What this type of valuation misses is the 'potential dividend' of the company as it only will pay out 50-75% of it's earnings. This means there will be cash left over which can be further invested, which in turn will increase value through additional earnings and higher dividends.

Perhaps that will be a topic for a future blog entry!

Daily Bitesize: The value today of a dividend tomorrow part II

In part one of this series of valuing dividends we looked at a simple Dividend Discount Model to understand the current share price of TeliaSonera, a telecommunications company that pays out a high dividend yield.

The assumptions required in this model, assured dividend payout and known dividend growth to eternity make this model in my eyes just slightly limited in its application! How can you seriously predict the dividend growth to infinity?? The less said about a company (or even the universe) existing for infinite amount of time the better!

Clearly we need to shorten the timeline....and dramatically. There are some ways around this but of course these modified models introduce their own assumptions. One way is to predict the dividends just a few years out, say for example 3 years, and then sell the stock at a predetermined price.

We then discount the sum of these dividends and the proceeds of stock sale at a certain discount rate. This is driven by the risk of investment and partly judgemental. Would I prefer $100 today or $105 next year? Perhaps then $110?

In the example below I have chosen 9%, for simplicities sake let's just say I like my money and the number nine! You are welcome to choose a higher or lower value, that's the beauty of the markets.

In example one (yellow) we have a 2.85 kr dividend being paid out for three years (i.e. no growth) and then sell the stock at today's price of 48kr. The sum of those pay outs and sale is discounted to give a present value. So for example the year 1 dividend is worth 2.85/1.09^1 which is 2.61kr, the year 2 dividend is 2.85/1.09^2= 2.40 and so forth.

As you can see the total price in today's money is 44kr, around 8% less than the current price. The second example (blue) has the dividend growing 5% each year but that doesn't really change the valuation at 45kr. Clearly over this relatively short period of time it is the selling price which drives the value.

As you can imagine one can modify the growth rate, discount rate and selling price ad ifinitum until you get a price you wish. The last example shows what selling price would be required in combination with 5% dividend growth and 9% discount rate i.e. 53kr to get a present value of around 48kr per share. This is now around 10% above the current market price.

Who knows what the future holds for TeliaSonera, maybe it will raise it's dividend in the near future, maybe it won't. If you value the company solely on its dividend and ignore other ways it may create value such as additional cash flow, reinvestment etc then it doesn't look a screaming buy.

However, let's change our mindset regarding this trade. We could be an optimist and conclude the stock may just be reasonably valued based on it's dividend and has upside potential as anything else it may produce would be a bonus.

The Horseman of Inflation

"By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens."- John Maynard Keynes

Here is a summary of what I learnt from the second chapter of William Bernstein's book 'Deep Risk: How History Informs Portfolio Design'

The list does not contain all the key facts from the book only those that were new or interesting to me.

• Curiously only 7 countries have had a combination of high long term equity returns (> 1% real, capital only) and tolerable inflation (<5%): US, Canada, Denmark, Netherlands, Noway, Switzerland and Sweden.
• Brazil had an annual inflation of 148% between 1947 and 1996!
• Severe and persistent inflation seems to reduce equity returns yet it does not always savage them e.g. Chile had 31% annual inflation 1927-1996 (508 million-fold rise in prices....mindboggling!!) but real equity returns were still 2.99% per year.
• Stocks suffer short term to inflation but protect against it in the long term, hence stocks add short term shallow risk but protect wealth over longer periods.
• Bonds in those nations with lowest trailing inflation had the lowest returns, whereas bonds in countries with the highest trailing inflation had the highest returns.
• It is surprises to the upside in inflation that decrease prices and damages bonds. (It is this point that really highlights for me the potential fragility and risks in the current bond market if/when inflation occurs).
• One possible strategy would be to wait a few years after inflation has kicked in and then jump in by buying bonds.
• A well diversified portfolio of international stocks is likely a good hedge against the deep risk of inflation.

The Four Horsemen

"Go to bed smarter than when you woke up." - Charlie Munger

Any new book by Bill Bernstein is a must read for me

'Deep Risks: How History Informs Portfolio Design' by William Bernstein

This is an excellent guide that takes a step back and looks at the bigger long term picture of investing and wealth building/protection.

Below is a list of what I've personally learnt so far or has tweaked my interest from reading the first chapter.

• The four deep risks: Inflation, Deflation, Confiscation and Devestation
• Capital managed in the long term (>30 years) should be guided by deep risk.
• Discipline (e.g portfolio re-balancing), cash and courage which act against short term shallow risk, do not mitigate deep risks.
• An example of a deep long term risk: Japanese large caps lost -58.2% from 1990-2013
• Historical studies show gold protects poorly against inflation, in fact performs better in deflationary periods.
• Harry Browne's permanent portfolio is flawed as it equally weighs the probabilties of prosperity (shares), inflation (gold), deflation (long bonds) and 'tight money' ( T-Bills) equally as well as their consequences and costs.
• Deflation less likely historically than inflation which savages bond returns.
• From 1941 to Sept 1981 (an inflationary period) US bonds lost 67.3% of real value (interest reinvested).
• Hence, bonds are an expensive insurance against the relatively unlikely long term outcome of deflation.

Daily Bitesize: Simple yet effective

Was amazed to see Avanza Zero is the fourth best performing Swedish equity fund from the past 5 years. It's a simple index fund (SIX30RX) that buys the top 30 traded companies, plus has no fees! So simple yet so effective.

I also plan to write about some simple strategies that have been shown to increase returns in these type of index funds.

Daily Bitesize: The value today of a dividend tomorrow

'Price is what you pay. Value is what you get'-Warren Buffett

When buying a dividend paying stock it's prudent to know if you are getting value for your hard earned cash. Pay too much and it could take many years, if at all, to get your money back.

One very simple way of valuing an income stream from a dividend is the 

Dividend Discount Model DDM.

The discount rate is a measure of how highly you value your money today and is connected to the risk of the investment. The more precious your money and the higher the risk of the company/dividend then the higher the discount rate.

For example the 'risk free' discount rate would be 10-year government bond as you are certain to get your money back at the end (we'll ignore inflation at the moment!). Due to the risks associated with a companies stock the discount rate would be some percentage points above this, around 5%, give or take a few points.

TeliaSonera is a Sweden based telecommunications company, most countries have them and as is the case with these companies it pays out a high dividend of 6%, 2.85kr. It's the most owned stock by Swedes and has a pay-out ratio of around 62%, so returns a significant amount of its profits back to shareholders in the form of dividends.

We will try to value its stock price purely by its dividend and the cash flow it provides, as if it were a perpetual bond. Below is a table of valuations based on the equation above using different inputs for the discount rate and dividend growth rate.

Ignore the purple areas, that is where the calculation breaks down as the discount rate must always be higher than the growth rate (it's one of the limitations of the calculation). I've highlighted in green the combinations that closely match the current stock price of 47.8kr.

At one extreme we have TeliaSonera being evaluated by the market as having no dividend growth with a fairly low discount rate of 6%. As the growth rate increases then so can the discount rate to compensate for any extra risk.

It should be noted the Telia's dividend has grown since the lows of 2008 but is still below 2005 levels. That's a rear view analysis of the dividend and doesn't really tell us what will happen in the future.

So there you go, the share price doesn't seem extremely overvalued based on the simple dividend discount model but is a little bit too rich for my tastes. Certainly no bargain.

This valuation does assume however that the dividend will be paid out for an infinite period of time and as we all know the saying goes, 'in the long run we are all dead'!

More valuations coming in future parts.

Mr Market: EM gets the cold shoulder

Let's take a quick look at which markets are most out of favour by Mr Market. Below is a table of the top 10 losing funds from the past 3-months (Source: Avanza)

We see big losses in the emerging market countries of Indonesia, India and Turkey. A deeper look reveals painful 40% falls since the highs of May. We must remember of course these markets may have moved from being overvalued to being reasonably valued.

As investors though what we really want to know is, are they are buy yet? Have they moved too far to the down side giving upside opportunity?

Without digging into valuations such as CAPE but looking purely % drawdowns at least 60'% may be a good time to buy in order to get good 3-year returns (Mebane Faber analysis).

That would imply another 30% drop from where we are now! Think about what that would really require in fortitude to buy an EM fund cut in half and act against 'end of the world' discussions in the news feeds. 

Today's Bitesize: Sweden & Taiwan

I must admit I was taken slightly aback today when reading the following report
 'Want Diversification? Invest in Sweden' by Morningstar UK. It grabbed my attention as it not only covered portfolio diversification but also mentioned Sweden in particular.

Well.....take a look at the the following graphic. It shows which stock markets are mostly correlated over 13-week periods the past 10 years. A blue line is a positive correlation and a red line a negative correlation.






Yes, that's right, Swedish equities positively correlate with the Taiwan market! Very strange but not only that, there has been a negative correlation with the US stock market. Sweden (along with the UK) seem to stand out from other European equities.

This is good news for diversifying your portfolio and provides an extra reason to assign Swedish equities their own allocation in your portfolio.

Remember: Correlations can change and what may have been true the past 10 years may not continue going forward.

Blog Reactivated & Rebooted

It's been a while since my last blog entry but the siren call became too difficult to resist, so I'm excited to say I've decided to reactivate and reboot this blog!
I'll probably redesign and reorganise things but as a start I've added to two new pages named 'Wall of Worry' and 'Mr Market'.

The 'Wall of Worry' is admittedly a slightly tongue-in-cheek look at the ever ongoing worries in the market. It's a simple list of reasons to be fearful and not invest but has a serious point. There will always be something to be worried about, that you can be sure of! Looking at this list I hope will put it all into perspective and help us to release it is a never ending and intrinsic part of the markets.

For those of you who have read 'The Intelligent Investor', Mr Market will be familiar to you. The difficult question is how do we really know what he is feeling and thinking? How do we take advantage of his mood swings? It is always obvious with hindsight but more difficult to gauge in the moment. This page may point us in the right direction and highlight possible opportunities.

The Match King!

He was called the ‘Match king’ for good reason, he had managed to negotiate match monopolies around the world including Europe and South America giving him control of up to three quarters of the worlds match production. By 1930 his empire controlled around 400 companies and 50% of the worlds iron ore and cellulose  market.

His speculating instincts had also led him to lend large sums of money to governments even when not knowing where the funds would come from. As security on these large loans he would then be granted monopolies further cementing his power, for example loaning Germany $125 million-dollars (almost $1.9 billion in today's money!) in the interwar years.


His name was Ivar Kreuger a Swedish engineer who became a financier, entrepreneur and industrialist. At his peak he managed to amass a fortune of 30bn Swedish kroner, over $100bn dollars in today’s money, but by 1932  he was dead of suspected suicide, another victim of the great 1929 stock market crash.

The crash had exposed questionable accounting practices where profits were reported when there were none and ever increasing dividends were paid out by attracting new investment and/or looting the treasury of a newly acquired company. This eventually proved fatal for his empire which was so powerful that it even precipitated a world wide ’Kreuger crash’.

Despite his empire being referred to as a great ponzi scheme some of his companies were real businesses and amazingly after 80 years his industrial legacy still lives on. He founded SCA, planning to set up a cellulose cartel using north Sweden’s forestry industry, as well as being a major stakeholder in the telephone company Ericsson (again planning a monopoly!), mining company Boliden and ball bearing manufacturer SKF.

In 1917 after merging several Swedish match companies he founded Svenska Tändstcks AB, known today as Swedish Match. Nowadays the company is a major player in the world with around $12bn sales in snus and snuff (smokeless tobacco), cigars and of course a market leader for matches across the globe.

The stock currently sells at around 217 SEK on the Swedish stock exchange, with a P/E 16 with dividend yield of 3.4%. Nothing out of the ordinary you might think but let’s take a look at some price action since the lows of 2009.



It has gone up like a rocket, around 175% trough to peak in 3 years. I’ve even put in the 50-week SMA to give a better sense of how powerful the uptrend has been.

However, since the middle of last year, something has changed in investor sentiment and they are now rushing for the exits pushing the price down 30% from a high of 294 SEK.

We’ve seen this pattern of course many times before, such as recently with Apple stock. A consistent uptrend, a blow off as ever increasing market expectations are not met, then a precipitous drop in price. 

It is another nice example of a companies stock price going up for what it feels like forever........until it suddenly doesn’t!

The danger of course is this type of price action can prove to be an irresistible trap and inexperienced investors without proper risk management can end up holding the bag with big losses.

A quick search of the internet reveals as late as March 2012 even experts Avanza were still recommending a buy at 250SEK (to be fair though their analysis did highlight market share challenges) however by August they switched to neutral just as the stock price reached it’s peak.

So what lies in wait for Swedish Match stock? Technically there has been a recent bounce so could it flatten out here but then again this correction may not be finished and it will fall further! The dividend yield should act as a cushion preventing further big losses.

Typically in this situations investor sentiment becomes too optimistic on the upside, so I expect we will swing back too far on the pessimistic side, pushing the price too far down making it cheap. This is where the opportunity for value investors will present itself, who will come in putting a floor in the stock price.

At what price does Swedish Match become a buy? From a behavioural point of view I would ideally be looking for the 'puke point' where the weak longs throw in the towel and the chat rooms are full of bearish sentiment. We don't seem to be at that point.