Portfolio Mix: Metrobank Investment Funds (UITFs)

In the light of the recent developments in the financial markets abroad, such as the uncertainty of the U.S Federal Reserves’ short to medium-term monetary policy stance, and the strengthening of the developed world economies (U.S, Europe), investor sentiment has been shifted away from emerging markets, such as the Philippines, and back into the financial markets of the developed world. This has resulted in an exodus of the portfolio investments from emerging markets, which has devastated emerging market currencies, reversing the year to date gains of the Philippine peso back to negative territory and has had a profound effect on the local interest rates in the Philippines over the past few months. Local interest rates have since transitioned back into a seemingly temporary lows, but given these developments, it is quite clear that we are entering into an environment of rising interest rates, which will impact bond prices, due to the inverse relationship of bond prices and interest rates/yields.

     In a rising interest rate environment, we recommend fixed income investments in instruments with tenors of less than 5 years, due to the lower level of interest rate sensitivity of lower tenor bonds.  We recommend an investment in the Metro Max-3 Bond fund, since the fund is primarily invested with short to medium term fixed income instruments that are less sensitive to interest rate risk. The fund has a weighted term to maturity of only 3.06 years and duration of 2.32. Historical returns of the Max-3 Bond Fund have been relatively stable with an average of 5.212% and a standard deviation (Volatility) in returns of only 0.90%.

Depending on your risk appetite, you may either choose to be 100% fully invested in fixed income instruments or may allocate a portion of your portfolio into equities in order to increase the upside potential of your investment, which may come at the expense of greater risk in terms of volatility of returns. Should you be willing to bear the additional risk, we recommend an investment in equities via the Metro Equity Fund, of at least 20-30% of your portfolio. This will give you an opportunity to directly capitalize on the transformation of the “Sick Man of Asia” into one of the fastest growing economy in Asia. The acceleration of growth in the Philippines over the next 2 years, with GDP growth expected at 6.5 – 7% for this year, and in the 6-7% range for the 2014 and 2015, will be a positive for the stock market, as an increase in economic activity led by robust consumer spending, will drive up corporate earnings.

Typhoon Haiyan a net positive in terms of economic impact:  Despite market’s negative reaction to the tragedy that is Typhoon Haiyan, the economic impact is expected to be muted, since production in the worst hit regions consist mostly of low value goods, while the economic contribution of the overall affected regions would only compromise of roughly 12% of the economy. The bulk of the effects are expected to be only short-term with inflation temporarily spiking at 3-4% in the last two months of the year and in the first quarter of next year in response to food production losses and supply chain disruptions. while, GDP growth rate is still expected to take a slight hit of 0.40% for this year, which may put full year growth below the 7% level, but still comfortably between 6-7% for the year. The typhoon may even be considered a positive for the Philippine economy, with reconstruction efforts, estimated to cost P250B (2.31% of Philippine GDP), seen to supplement the economic growth in the coming years.

As you can see on the tables above, periodically rebalancing the portfolios at year end back to their original allocation weights has provided for incremental returns over the similar set of portfolios that were not rebalanced. In the case of the moderate fund, the difference in annual compound returns is 0.922%. while, for the the aggressive portfolio, the difference in annual compound returns is 1.214%. Clearly, period rebalancing has been beneficial.

Disclaimer: Author is currently affiliated with Metrobank, although he derives no commissions from actual bookings that may result from this recommendation. This article was created to show the authors views and recommendations on Metrobank’s UITF Products, and an objective description of the historical performance of such. 

To get the latest updates on Metrobank’s UITFs, inquire at the Metrobank nearest to you. 

My take on Estimating and Forecasting the PSEi

There is quite a bit of uncertainty on where the PSEi will eventually close at during the year end. Early in the year, initial estimates put the figure at an optimistic level of 7200 to 7400, which was subsequently adjusted downwards to 6500 to 6600 level, following the correction that happened after May of this year. Given the current movement of the index during the start of november, that may now even seem to be a bit of a stretch. Especially if the markets continue to weaken. As of this writing, the PSEi was down to 6297.11 (10:05 am. 11/19/2013).

I decided i would give a shot at making an estimate of what the PSEi will close at for the year-end, so i decided to dig up a paper i worked on back in university, on “Forecasting Philippine Stock Market Returns with Macroeconomic Variables”. This will actually be an extension of my previous work, using new additional sets of data from the years after the periods covered in the paper. I specified and estimated a model of the Philippine Stock Market (Proxied by the PSEi), with the independent variables Country Risk (Now Proxied by CDS 5 Yr.), Industrial Production, USD/PHP Exchange rate, 10 Y Treasury Bond (PDST-F 10 Y), and the Inflation rate.

The graph above shows the estimated and actual values of the PSEi, the specified model does a decent job of estimating the PSEi, although it isn’t perfect, but having an estimate is always better than pulling a number out of thin air. The model forecast that the PSEi will end the year at the 6600 level, and will climb to 7900 and 8800 levels for 2014 and 2015. respectively. These forecast are based on plugging in estimated values for the independent variables for the years concerned. Although it is important to note that the model is only as good as the variables that come into it.

On a totally unrelated note, and just for the fun of it, although i’m not a chartist, there seems to be a consolidating triangle pattern forming for the price movements of the PSEi as of yesterday(11/18/2013). The PSEi can go either up or down, if it pierces the next low, then the PSEi may fall sharply and continue to weaken.

For more information on the model, or any questions, you may contact me.

 

Strategy Backtesting: Systematic Macro Indicator based

I’ve been working on a strategy based solely on a macro indicator that provides timely trade signals for entry into the Equity Market. All investment decisions are based on the movements of the indicator index, leaving no discretion to the investor, with the exception of the choice of investment funds to represent the required exposures in Fixed Income and Equities.

For more information, or any interest in my work, don’t hesitate to contact me.

Finding Value: Travellers International Hotel Group

Just sharing some facts, along with my views and opinion on Travellers International Hotel Group, Inc., which is scheduled for listing on the 5th of this month.

Disclosure: I have no subscriptions to the IPO of this company, nor plan on taking any positions on this company for the foreseeable future. This is unpaid research, which i have done out of the goodness of my heart, for the love of finance, and to simply demonstrate my skills.

Please don’t hesitate to comment. Feel free to point out any errors or things that i may have missed out, unreasonable assumptions, or any disagreements on my opinions. Any ideas would be greatly appreciated.

 

Revisiting my previous post: Philippine Bond and Equity PER.

Just something interesting to note. Adjusting earnings for inflation, Bond and Equity PERs have tended to follow each other more closely than shown on my previous post. Prior period divergences between Bond and Equity PERs were always followed by an eventual convergence, with the exception of the latest divergence between the two that started in Q3 2012, which has yet to be close out.

In my previous post, i’ve pointed out some points that would support an eventual convergence between Bond and Equity PERs in the Philippines, but an argument can be made for a case that the convergence may never take place, well, at least not anytime in the near foreseeable future. The bull market in bonds that peaked prior to May 2013, was brought in part due to an expectation of the Philippines finally attaining the coveted investment grade rating from all the major rating agencies (Fitch, S&P, Moody’s), which it has achieved with the last major credit rating agency, Moody’s, upgrading the Philippines to Baa3 earlier this month.

Considering that the Philippines is now rated Investment Grade, the markets may be pricing in a premium in the form of a higher PER. This view would be consistent with the elevated PER ratio for bonds during the run up to and after attainment of the IG rating. During the prior periods when Bond and Equities PER had a tendency to converge, Philippine Debt was considered to be of junk bond status, which in theory is considered to be just as close in terms of riskiness with common stocks. Should the markets continue to price in a premium on Philippine Bonds, then the likelihood of a convergence in the foreseeable future is quite low. This event may even mark the beginning of a new trend for Bond PERs charting a new course, should this continue to persist.

Suppose that my hypothesis is false, and there would be an eventual convergence between the Philippine Bond and Equities PER, then there may be a couple of possible events off the top of my mind that would in my opinion result in a normalisation of local interest rates in the Philippines, which should depress Bond PERs. One would be the U.S Federal Reserve tapering the QE bond buying program, which is contingent on strong U.S Growth data and isn’t expected to happen until at least March 2014 (Due to continued weakness in U.S economic data and the effects of the recent government shut-down). The other being an overheating of the Philippine economy, that would force the BSP to raise interest rates to stave off higher inflation (Not likely yet since last month’s inflation came in at 2.7%, well below the BSP target of 3-5%) or even raising interest rates in reaction to external pressures that may threaten the local economy. Third, some black swan event that would result in an increase of interest rates to levels unseen since 2008. Fourth, a strong resurgence of a bull market in Philippine Equities could close the gap and based on the growth fundamentals of the economy, this may be achievable within the next 2-3 years.

Given the following recent developments, the push back of QE Tapering to a later date next year (Evident in the U.S Treasury 10 Year Bond yields down to a 3 month low of 2.49% as of this writing), The BSP continuing to keep Benchmark rates unchanged at their current low levels, and the exodus of the hold-out SDA funds come November, the combined effect of all this is to keep bond yields relatively low for at least until early to mid next year. If there is to be a convergence of Bond and Equities PER, then my guess is that it may occur either in the middle or late next year. Either way, Philippine Equities still have the greater upside potential, which should be reason enough for being bullish on it over Bonds.

One chart to show why you should be bullish in Philippine Equities and underweight in Bonds.

Over the last 6 years, the estimated Price to Earnings ratio of the 10 year Philippine Government bonds and the Price to Earnings ratio of the PSEi index has converged in over four separate periods of time, and has had an average difference of 1.08 between them.

Since Late Q3 of 2012, both figures have diverged considerably, with the Bond PER rising significantly relative to the Equity PER. Although both bonds and equities have since corrected from their peaks from early this year, they have yet to re-converge.

This re-convergence would certainly be helped with the eventual normalization of interest rates to more sustainable levels, and a turn around in the Equity markets on the back of the strong growth fundamentals of the Philippines once external pressures are alleviated.

Value and Price, what’s the big deal?

   To best explain this, i felt it best to illustrate my experience the previous afternoon. Everyone has that unique way of staying awake past the afternoon, mine happens to be through a cup of tea, although I prefer mine cold rather than hot. Just the other afternoon I was frenetically searching for some ice to cool my afternoon tea, yet I couldn’t find any in sight. Out of desperation, I found myself queuing at a food stall in a nearby food court. I asked Tindera if they were willing to just sell me the ice instead of a drink, to which she and her fellow co-workers vehemently said No! I then said, “Okay, I’ll buy a large soft drink, sans the soft drink, all I want is the ice.” They simply stared at me puzzled, as though I was a crazy person. Although after much hesitation they eventually agreed to sell me the large soft drink ,sans the soft drink for the nominal price of P30, it didn’t come without the awkward stares from both the Tinderas and the customers who became spectators to all this. They all probably thought I was nuts to pay the full price of P30 for a large soft drink, but instead take only a large cup full of ice.

On the basis of the price that I had paid for the cup of ice relative to the going price in a convenience store/ or grocery, I would have seemed rather foolish to have done what I did and that was probably how the Tinderas viewed me, but they all failed to see and realize one important variable, the value that I attached to having my afternoon tea at my preferred temperature. P30 is a measly price relative to what I would be willing to pay to have my afternoon tea just the way I like it. In fact, I would venture out to say that I would have probably even been willing to pay far more than that amount. My experience shows the stark contrast between Value and Price, with the latter being the current market rate on an arm’s length transaction for a product or service. While the former is a subjective idea on your own expectations on the potential benefits that can be derived from the product or service. So long as your expectations on the benefits to be derived exceeds the price that you actually pay for that product or service, then you are better off and as economist call it, maximizing utility.

Let’s put this in the context of investments. A security or financial instrument, whether it be a bond or a share of stock is valued partly based on the expectations of their future cash flows. Now let’s take a company XYZ Corp., each market participant is presumed to have his/her own opinion on the ability of that company to generate a future set of cash flows, and it is this very opinion that forms expectations on the likelihood of the realisation of those cash flows and a corresponding required rate of return for the participant to assume the risk inherent in those cash flows , which subsequently leads to an investment decision of whether to buy or sell the share of stock of XYZ Corp. Each trade made by market participants is a reflection of their views and opinions on the future financial performance of the company and on where the stock price ought to be, and it is this very interaction between the different market participants as they express their views that leads to the market price in a process called price discovery. This process of price discovery is rarely a straight forward and efficient process, especially in emerging markets, such as the Philippines, that are characterized by thin trading ( Low trading activity), asymmetric distribution of information, opaque markets, etc. Thus, it is not unheard of for market prices to veer quite far from the range that the company’s fundamentals would suggest.

     So what are the implications for this? 1st, the eventual convergence of price and intrinsic value requires action on part by market participants in the form of trading activity, which may be a long-term phenomenon, as companies tend to go in and out of favour with the market. 2nd, the ability to value a security more accurately relative to the market has potentials for high pay-offs.

•      Do your own research, the worst advise is free advice. Never ever take investment advice from those amateurs parading as pros on the online forums and take your broker’s recommendation with a grain of salt. Conduct your own research on the company’s financial performance and form your own opinions and expectations based on both the quantitive and qualitative information.
•      Buy the stock so long as it is below your target price, be confident with your ability to value the stock and commit to it. Your long-term rate of return should be greater or equivalent to your required rate of return so long as you buy the stock below or at your target price.
•      You are in it for the long-term, stick to your idea of value regardless of what happens to the stock price in the short-term, your broker or colleagues may even call you nuts for holding on to it, but don’t you dare listen, what is important is your own perception of value. Should the stock price take a plunge, average down your cost by accumulating more of the stock, provided that nothing material has happened to the company’s fundamentals.
•      Keep on top of things, be sure to regularly update your valuation based on any new relevant information that may materially change the fundamentals of the company over the long-term.

Protected: An interesting indicator based strategy that has yielded 23.64% in YTD returns as of 10/3/2013.

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