Leverage in your investments...

[focus1974]

I am currently thinking seriously about leveraging.

Here is the scenario I am working on. All comments welcome.

Allianz Income and Growth Fund SGD pays about 8% pa. This fund has been fairly consistent in paying this level of dividend monthly. Currently the rate is S$0.075/unit per month and has been like this since Sept 2013. Current NAV is $10.6 so that works out to be around 8.5% pa.

Concept is sound. That's what HNWs and recently priority customers have been doing for years.

The Wealth Journey: Why HNWs like to leverage on Bonds to earn the spread?

However, for your case, you are using a BOND FUND which is not the same as a BOND. And you rightly pointed out the NAV thingy. Another unknown is whether they will be redemption forcing you to take a permanent loss of NAV. Unlike a Straight Bond that is CAPITAL GUARANTEED(till the company go bust or defaults) if you hold it to maturity.

No right or wrong answer. It's your risk appetite.

 

[RM2SSG]

Concept is sound. That's what HNWs and recently priority customers have been doing for years.

The Wealth Journey: Why HNWs like to leverage on Bonds to earn the spread?

However, for your case, you are using a BOND FUND which is not the same as a BOND. And you rightly pointed out the NAV thingy. Another unknown is whether they will be redemption forcing you to take a permanent loss of NAV. Unlike a Straight Bond that is CAPITAL GUARANTEED(till the company go bust or defaults) if you hold it to maturity.

No right or wrong answer. It's your risk appetite.

Thanks for the comment.

The fund focused on three instruments; high yield bonds, convertible bonds and equities. The manager balance the portfolio with the objective of attaining the dividend I mentioned in the last post.

You brought up a good point on forced redemption, something I will have to clear up with the bank.

Also note that I am looking a LTV of 50%, which I hope would further lower the risk.

 

[the bees]

there is no guarantee in life. The only 2 things that are guaranteed are death and taxes.

i also never say the 10% is guarantee. Dont twist my words leh

There is one more thing that is guaranteed in life - Change.

 

[Shiny Things]

The fund focused on three instruments; high yield bonds, convertible bonds and equities. The manager balance the portfolio with the objective of attaining the dividend I mentioned in the last post.

How are they getting an 8% yield out of a portfolio that's 40% large-cap growth equities (yielding about 2%) and 30% high-yield USD bonds (yielding about 6%)? They're either returning capital and calling it a dividend, or they're leveraged up to the eyeballs - so if you leverage up to buy it you're kind of doubly leveraged.

Update: Aha, answer found: they're writing covered calls on the portfolio, which helps fund the dividends. So they're buying equity vol through convertible bonds, then turning around and selling it right back by selling equity options. This is not particularly insensible - convert-arb funds do it all the time - but this looks like basically a hodgepodge of high-yield bonds and covered-call writing, not a focused convert-arb strategy.

(Also, leveraging up an options-selling strategy is always, always a recipe for tears. The risk profile of this thing is a lot more like an equity fund than a bond fund, which means more tears when equities have a drawdown.)

 

[RM2SSG]

How are they getting an 8% yield out of a portfolio that's 40% large-cap growth equities (yielding about 3%) and 30% high-yield USD bonds (yielding about 5%)? They're either returning capital and calling it a dividend, or they're leveraged up to the eyeballs - so if you leverage up to buy it you're kind of doubly leveraged.

My assumption is that Allianz is good at doing what they do that is why they are paid the 1.5% management fees.

In your opinion, how could a retail investor be able to find out how the dividend is generated?

Your brought up a good question which I would love to have answer to.

 

[Mecisteus]

I am currently thinking seriously about leveraging.

Here is the scenario I am working on. All comments welcome.

Allianz Income and Growth Fund SGD pays about 8% pa. This fund has been fairly consistent in paying this level of dividend monthly. Currently the rate is S$0.075/unit per month and has been like this since Sept 2013. Current NAV is $10.6 so that works out to be around 8.5% pa.

If I put in 100K, my dividend pa is 8% as per what the fund is performing.

If I do a 1:1 leverage, my investible amount is now 200K, minus OD fees (of say 2%), the IRR (over 3 years) is estimated to be at 14.67% pa. after minus off the OD fees.

The assumption is that the NAV remained the same.

My risks are:

1. OD rate jumped - but if I track it very tightly, I can get out before it is too late
2. The fund is SGD hedged, so I do carry currency risk
3. The fund focused on US market, so my market risk is in the US
4. NAV dropped significantly - this I can track and get out before too late
5. Dividend dropped significantly - if this happened gradually I still have time to get out

So effectively I am leveraging on 2% (of OD) to get about 6.67% extra yield.

Sounds too good to be true isn't it?

- fund is 1/3 each in high yield bonds, convertible bonds and equities. so you should expect a higher volatility than a bond fund.

- the fund NAV has appreciated by 10% since listing. so the dividends are partly from capital gains too.

- good thing is the dividends is paid out monthly so you can lock your gains quickly.

- fund size is relatively huge. unlikely to close down so soon.

- if you look at the holdings, they are majority in the US. doesnt matter if your fund base is in SGD. you will face currency risk.

- effective duration of the high yield bonds is 3.66 years. quite short so interest rate risk is lower

- top equity holdings are gilead sciences, intel, oracle, apple and microsoft. i think they are stocks with good fundamentals. i have 2 of the 5 stocks there.

overall, i think it is a good fund. you may consider leveraging if you can get a loan of <2% and you can stomach a max drawdown of 30%. try asking for a USD loan instead. interest rate should be lower and you can hedge your currency risk with the USD loan.

 

[Shiny Things]

My assumption is that Allianz is good at doing what they do that is why they are paid the 1.5% management fees.

No, they get paid the 1.5% because they're good at making you think that they're good at what they do.

Some mutual fund managers are consistently good - Peter Lynch, Bill Gross, etc etc etc. A majority of them aren't - and it's almost impossible to find any that are consistently (and consistently is the key word here - one underperforming year and you've hosed your returns for years) good enough to justify fees as stratospheric as 1.5%.

In your opinion, how could a retail investor be able to find out how the dividend is generated?

Your brought up a good question which I would love to have answer to.

So we can sort of add those three parts up, smoosh them together, and we can take a pretty good stab at "how the dividend is made". There's a convert bond part; a large-cap-stocks-plus-covered-calls part; and a high-yield bond part.

The convertible bond part is basically "buy bonds plus buying equity options", because that's what a convertible bond is, a bond plus an embedded equity option. The long options part of the convert bond part nets out with the short options part of the stock part, leaving us with:

* Convertible bonds minus equity options = corporate bonds
* High yield bonds
* Covered calls minus equity options = large cap stocks

So when you strip out all the fancy stuff, this is basically a 30-30-30 IG bonds - HY bonds - large cap equities fund, which creates a "dividend" by a mix of actual dividends, bond coupons, and then a big slug from selling options.

In fact, I'd bet that the performance of this thing looks a lot like a 50-50 mix of a stock fund and a bond fund... give or take some phenomenal fees.

--------------

And we can test that guess!

Here's a fun thing. One of the many bells and whistles you get with an Interactive Brokers account is their "mutual fund replicator" tool. You give it the name of a mutual fund or unit trust, and it uses simple regression to pick the best-correlated ETFs that let you replicate the mutual fund without paying the sky-high fees.

And our Allianz Growth and Income fund is in their list of funds. Let's punch it in and see what happens.

And here's your result. Well well well, have a look at that.

The "highest correlated compound ETF" section (in orange) says that this product looks exactly like - and I do mean exactly, the correlation's about 98% - a 50-50 portfolio of a bond fund (the Guggenheim Bulletshares 2017 fund) and a stock fund (the Vanguard S&P500 index tracker). Called it!

But the unit trust charges 1.5% per annum, and the two ETFs charge a combined 0.06% per annum for exactly the same performance. Man, if I could get paid three million a year for putting other people's money in a boring stock-and-bond mix...

And if that's too hard, if you'd rather have it all in one place, the unit trust has a 92% correlation with USMV, the iShares MSCI USA Minimum Volatility fund. Again, it charges 0.15%, which is a whole lot less than you're paying for the unit trust.

So if you're really insistent on doing this leveraged investing thingy (and personally I don't think it's a good idea), why not save yourself an extra 1.5% per annum and do it via ETFs? With the leverage effect, that's an extra 3% per year in your pocket. You've just about covered your interest costs right there.

------------

There is of course a catch to the ETF strategy - there's always a catch - and that is that you have to hedge the currency risk, because your assets are in USD but you live in Singapore and will probably take out a SGD loan to do this thingy.

You've got two options.

#1: take out a USD loan instead of an SGD loan. This is not technically a bad idea, but it still leaves you with a bit of an exposure, because you've presumably got some SGD collateral for the loan. It gets a bit gnarly.

#2: sell some USDSGD FX against the position to hedge it out.

#3: Leave the position unhedged. This is extremely unwise, because then you've got a big slug of USDSGD FX risk on top of the leverage.

(The other catch to the ETF strategy is that it keeps the "8% yield" in the fund instead of paying it out as dividends. The end result is the same, though: more money in your pocket.)

MikeDirnt: the fund class is actually hedged back to SGD, I think, so it's got the currency hedge built in. The ETF way wouldn't have the built-in hedge.

 

[Mecisteus]

wow Shiny i didnt know IB got such function.

then might as well do portfolio margin with Interactive Brokers if you can put >100k. you can go ahead to buy those ETF through IB also and you can replicate the same performance at a much cheaper cost.

just FYI, i do leverage with CFD stocks in IB. their rates and commissions are dirt cheap. my gross leverage is about 1x to 3x and my return net of all fees so far is about 2x of S&P/Dow/STI.

 

[RM2SSG]

Shiny Things and MikeDirnt78, thanks for the comments. A lot for me to digest.

Here's a question. If it is so easy to replicate the strategy of a fund, wouldn't fund houses stop existing?

 

[focus1974]

cRAZY RIght..

We retail players are competing against the likes of SHINY in investing.
He can dissect the components and tell us in detail what they are doing.
Scary thought how many more of SHINY out there in the market ...

 

[wahkao3]

cRAZY RIght..

We retail players are competing against the likes of SHINY in investing.
He can dissect the components and tell us in detail what they are doing.
Scary thought how many more of SHINY out there in the market ...

yep, he is very good.

its ok, just invest in what you are good at.
if you are good at stocks, go stocks
if you are good at fixed income, go fixed income

no need to know everything


in general, dont invest in funds, they suck! you as a small retail investor have much more advantage than these funds.

unless the fund is warren buffet's

 

[Shiny Things]

Shiny Things and MikeDirnt78, thanks for the comments. A lot for me to digest.

Here's a question. If it is so easy to replicate the strategy of a fund, wouldn't fund houses stop existing?

Because here's the thing - it's easy to replicate these mutual funds if you know how. Those last four words are key. I spent years learning how to do this stuff, but the average person doesn't have a clue... so they can be persuaded by a fancy brand name and some slick marketing, and they'll never ever realise that they're paying 1-2% for something that can be had for 0.05% elsewhere.

In America, at least, people are starting to realise this. Last year, of all the new money that went into mutual funds in America, something like 97% went to Vanguard - low-cost, boring, index-fundy Vanguard. This trend will come to Asia eventually.

And until it does, I'm just here doing my little bit to try to help save people money.

(Also, not all of them are easily replicable. You'd have trouble replicating Pimco Total Return, for example; I ran it through the replicator and couldn't come anywhere close to its performance. But equity funds - especially the big ones - tend to turn into closet indexers, which makes them more amenable to this sort of low-cost replication.)

We retail players are competing against the likes of SHINY in investing.
He can dissect the components and tell us in detail what they are doing.
Scary thought how many more of SHINY out there in the market ...

Mate, that's the thing: you don't need to compete against me. The reason I go so hard with the "buy and hold index ETFs" line is that that way, you're not competing against me or anyone. You don't need to worry about hedge funds, or short squeezes, or excessive fees, or high-frequency trading, or penny-stock meltdowns, or shadowy figures manipulating the gold market for their own evil ends, or whatever the latest paranoid-delusional fantasy doing the rounds on Zero Hedge is.

If you keep your investments simple, keep your fees low, and keep your hands off the "Buy/Sell" button, you can literally just sit back and relax and watch the money roll in.

Seriously, the hardest part of investing is just learning to sit on your hands and not panic. Nothing will ruin you faster than overtrading and panic-selling whenever stocks fall 5, or 10, or 20 percent.

 

[genie47]

In other words. Get a plan up. Buy the ETFs, bonds and stuff you need. Go into a cave. Practice the 5 Finger Exploding Heart technique. Don't look at the investment. Come out a year later after mastering 2 Finger Exploding Heart technique. Rebalance. Repeat. Hopefully next year, you will have mastered 3 Finger Exploding Heart technique.

 

[leobox1]

How are they getting an 8% yield out of a portfolio that's 40% large-cap growth equities (yielding about 2%) and 30% high-yield USD bonds (yielding about 6%)? They're either returning capital and calling it a dividend, or they're leveraged up to the eyeballs - so if you leverage up to buy it you're kind of doubly leveraged.

Update: Aha, answer found: they're writing covered calls on the portfolio, which helps fund the dividends. So they're buying equity vol through convertible bonds, then turning around and selling it right back by selling equity options. This is not particularly insensible - convert-arb funds do it all the time - but this looks like basically a hodgepodge of high-yield bonds and covered-call writing, not a focused convert-arb strategy.

(Also, leveraging up an options-selling strategy is always, always a recipe for tears. The risk profile of this thing is a lot more like an equity fund than a bond fund, which means more tears when equities have a drawdown.)

Hi .. If my intention is to have no leverage, just buy and hold .. Earn dividend and slow growth of the investment. Simple life. Is this fund ok?

Thanks.

 

[Shiny Things]

Hi .. If my intention is to have no leverage, just buy and hold .. Earn dividend and slow growth of the investment. Simple life. Is this fund ok?

Thanks.

No. The Allianz fund charges WAY too much in fees; you'll be handing them about 1% of your money every year, and over 20 or 30 years that's a HUGE amount of money coming out of your pocket.

You'll get better performance at a lower cost from a 50-50 portfolio of LQD (a US corporate bond ETF) and SPY (a large-cap US stock ETF) (or, for the tax savings, the UK-listed equivalents: LQDE and VUSD respectively). Fire up your Stanchart account; buy some LQDE and some VUSD; and sit back and relax.

 

[hysteriakx]

No. The Allianz fund charges WAY too much in fees; you'll be handing them about 1% of your money every year, and over 20 or 30 years that's a HUGE amount of money coming out of your pocket.

You'll get better performance at a lower cost from a 50-50 portfolio of LQD (a US corporate bond ETF) and SPY (a large-cap US stock ETF) (or, for the tax savings, the UK-listed equivalents: LQDE and VUSD respectively). Fire up your Stanchart account; buy some LQDE and some VUSD; and sit back and relax.

sorry to hijack the topic but i wanted to ask if theres any free backtesting software to test the equity bond ratio?

the part about mutual fund replicator, is it a case of over optimization? shouldnt it be something like a in sample and out of sample test to verify?

 

[hysteriakx]

and since we're talking about passive management, are tilted funds worth the extra fess?
small cap, value stocks and possibly momentum factors

 

[Shiny Things]

and since we're talking about passive management, are tilted funds worth the extra fess?
small cap, value stocks and possibly momentum factors

In theory, the small-cap effect and the value effect exist, and some people like to tilt their portfolios to take those into account. In practice you don't want to plow your entire nest egg into small-cap value (especially given where small-cap valuations are at the moment - the Russell 2000's PE is somewhere north of seventy).

I usually just ignore it; I'm happy with my large-cap SPY.

sorry to hijack the topic but i wanted to ask if theres any free backtesting software to test the equity bond ratio?

You could probably do it yourself in R or Mathematica if you're so inclined; IBKR's mutual fund replicator thingy just regresses the total returns of a bunch of ETFs against the total return of a given mutual fund. It's nothing fancy.

the part about mutual fund replicator, is it a case of over optimization? shouldnt it be something like a in sample and out of sample test to verify?

No - you're not trying to build a trading model here; you're just trying to answer the question "what ETF has the highest correlation of returns with fund XYZ? What about a pair of ETFs?". There's no overfitting because you're not fitting anything.

 

[hysteriakx]

No - you're not trying to build a trading model here; you're just trying to answer the question "what ETF has the highest correlation of returns with fund XYZ? What about a pair of ETFs?". There's no overfitting because you're not fitting anything.

i mean what it does is to regress the past returns data with returns of several ETF and choose the one with the highest correlation over the past period. whether it would continue to have high correlation in its future performance is unknown?

 

[starsaver]

bookmarked !!