Business Times - 19 Nov 2007
Ratios to judge a firm's health
CHEN HUIFEN looks at key financial ratios that can help to evaluate the comparative performance of companies
IN OUR previous two instalments, we discussed the value of annual reports, and how investors can pick out useful information from both the prose and numbers.
We also looked at the fundamentals behind the three main financial statements - the profit and loss statement, the balance sheet and the cash flow.
Based on the information above, analysts can derive key financial ratios that help them in their assessment of a company's past and current health. To draw a simple analogy, some consumers base their car buying decisions on the fuel mileage they can get. Similarly, financial ratios are tools to judge the comparative performance of companies.
There are probably some 20 major financial ratios that analysts can churn out when they evaluate the operating performance and capital structure of companies. Here, we pick out some of the key ones.
Net profit margin
Net profit margin measures the amount of money a company makes for every dollar of sales generated. So, the higher the number, the better. It is typically presented in percentage terms. For example, Singapore Press Holdings (SPH) recently reported a full year net profit of $506.2 million, on a revenue of $1.16 billion. Its net profit margin is therefore
Net profit/revenue = $506.2 million/$1,160 million
= 43.6 per cent.
Return on equity
Commonly referred to as ROE, return on equity indicates how effectively a company generates profits out of its shareholders' funds compared to its peers in the same industry. There is more than one way of calculating ROE. The simplest is
ROE = Net profit/Shareholders' equity
So if a company makes $506.2 million and has shareholders' equity of about $2.2 billion, then its
ROE = $506.2 million/$2,200 million
= 23 per cent
Earnings per share
One of the key indicators of profitability, earnings per share or EPS is derived by dividing the net profit by the number of shares issued. So if a company makes $506.2 million and has 1.58 billion shares, then its
EPS = net profit/total weighted average number of shares
= $506.2 million/1,580 million shares
= $0.32 (or 32 cents)
Price to earnings ratio
With the EPS derived above, you can generate the price to earnings (PE) ratio. Analysts usually compare the PE ratios of companies in the same industry to judge if they are expensive or cheap when benchmarked against their peers. Note that the PE is influenced by a number of factors, including the price volatility of the company's share on the stock market and its earnings growth. Typically, the higher the PE, the greater the expectations of a company's future outlook.
Hence, if a company is trading at $4.50 and has an EPS of $0.32, then its
PE = Share price/EPS
= 4.50/0.32
= 14
Price to book value
Like the PE ratio, the price to book value (or PTB) is often used to compute stock values. The 'price' in PTB refers to the common stock price, while the 'book' is the book value of equity - the difference between a company's assets and its liabilities. In other words,
PTB = Market capitalisation/Total book value of its equity
One of the disadvantages of using PTB is that it is subject to accounting decisions on depreciation and other variables. On the other hand, it provides an alternative ratio to look at if a company is in the red, and therefore has no PE ratio to speak of.
Dividend yield
Dividend yield is the amount of dividend a shareholder can collect for every share that he owns.
Hence,
Dividend yield = Annual dividends received per share/Share price of the stock
As an example, SPH will be paying out 26 cents per share this year, so its dividend yield is therefore
26 cents/448 cents (price of stock as of Friday) = 5.8%
Gearing
Also known as financial leverage, gearing gives an idea of how a company funds its business - what proportion of its operations is being financed through debt, against shareholders' funds?
Gearing = Long-term liabilities/Shareholders' funds
Bear in mind that financial ratios should be evaluated together with knowledge of the company's operations, strategies and trends in the industry. None of them is meaningful on its own and should not be taken as the ultimate guide to a company's value. They should be looked at in conjunction with developments of the company, the performance of its peers, and not least, macroeconomic trends.
Monday, November 19, 2007
BT: Jasper unit buys 55% stake in offshore oil firm Neptune Marine
Business Times - 19 Nov 2007
Jasper unit buys 55% stake in offshore oil firm Neptune Marine
SINGAPORE - Singapore-listed Jasper Investments said on Monday that its unit will buy a controlling stake in Cyprus-based Neptune Marine Oil and Gas for US$198.4 million.
A company statement said that Jasper's unit Turquoise has agreed to buy a 55.44 per cent stake in Neptune.
Related link:
Click here for Jasper's press release
Neptune, which trades in Norway's over-the-counter market, acquires older low-cost offshore drilling rigs, refurbishes them with the latest drilling equipment and then contracts them out to major oil and gas exploration and production companies.
Singapore has seen a number of acquisitions in the offshore oil industry as interest in rig-building assets heats up amid record oil prices.
Dubai Drydocks World last month agreed to buy Labroy Marine for US$1.63 billion - its second acquisition in Singapore after it bought shipyard operator Pan-United Marine.
-- REUTERS
Jasper unit buys 55% stake in offshore oil firm Neptune Marine
SINGAPORE - Singapore-listed Jasper Investments said on Monday that its unit will buy a controlling stake in Cyprus-based Neptune Marine Oil and Gas for US$198.4 million.
A company statement said that Jasper's unit Turquoise has agreed to buy a 55.44 per cent stake in Neptune.
Related link:
Click here for Jasper's press release
Neptune, which trades in Norway's over-the-counter market, acquires older low-cost offshore drilling rigs, refurbishes them with the latest drilling equipment and then contracts them out to major oil and gas exploration and production companies.
Singapore has seen a number of acquisitions in the offshore oil industry as interest in rig-building assets heats up amid record oil prices.
Dubai Drydocks World last month agreed to buy Labroy Marine for US$1.63 billion - its second acquisition in Singapore after it bought shipyard operator Pan-United Marine.
-- REUTERS
PM Lee says '08 growth to slow: CNBC
Business Times - 16 Nov 2007
PM Lee says '08 growth to slow: CNBC
SINGAPORE - Singapore's prime minister expects economic growth to slow next year and predicts inflation will run at 4-5 per cent 'for some time' in 2008, CNBC television quoted him as saying in remarks released on Friday.
'I don't expect that we will go into a recession, but it won't be like this year,' Prime Minister Lee Hsien Loong said, according to an extract from an interview with CNBC to be broadcast on Saturday.
Singapore will release final third-quarter GDP data on Monday and a Reuters poll of economists predicts the economy grew at an annualised rate of 6.4 per cent in the quarter, matching an official advance estimate, as booming construction and services offset manufacturing weakness.
Mr Lee reiterated the government's forecast for the economy to expand at the high end of a 7-8 per cent range this year compared with 7.9 per cent in 2006.
The government's growth forecast for next year is 4-6 per cent and Mr Lee said he expected an update on the official forecast within days.
Mr Lee, who is also Singapore's finance minister, said he was watching inflation carefully, adding that the effect of higher prices for oil, food and the impact from a rise in sales tax on July 1 would become visible in the consumer price index in the coming quarters.
'I expect that the property prices will also show up in the CPI ... and therefore I think next year the CPI will be 4-5 per cent for some time.'
-- REUTERS
PM Lee says '08 growth to slow: CNBC
SINGAPORE - Singapore's prime minister expects economic growth to slow next year and predicts inflation will run at 4-5 per cent 'for some time' in 2008, CNBC television quoted him as saying in remarks released on Friday.
'I don't expect that we will go into a recession, but it won't be like this year,' Prime Minister Lee Hsien Loong said, according to an extract from an interview with CNBC to be broadcast on Saturday.
Singapore will release final third-quarter GDP data on Monday and a Reuters poll of economists predicts the economy grew at an annualised rate of 6.4 per cent in the quarter, matching an official advance estimate, as booming construction and services offset manufacturing weakness.
Mr Lee reiterated the government's forecast for the economy to expand at the high end of a 7-8 per cent range this year compared with 7.9 per cent in 2006.
The government's growth forecast for next year is 4-6 per cent and Mr Lee said he expected an update on the official forecast within days.
Mr Lee, who is also Singapore's finance minister, said he was watching inflation carefully, adding that the effect of higher prices for oil, food and the impact from a rise in sales tax on July 1 would become visible in the consumer price index in the coming quarters.
'I expect that the property prices will also show up in the CPI ... and therefore I think next year the CPI will be 4-5 per cent for some time.'
-- REUTERS
Saturday, November 17, 2007
Analyst report on CSC
CSC Holdings - Sterling Results (Results)
15 Nov 2007
In 1H08, revenue jumped 245% YOY to S$185m while net profit surged 296% to S$19.1m.
Strong organic growth resulting from the buoyant Singapore construction sector, coupled with the acquisition of L&M Foundation, Soil Investigation and G-Pile Sistem, contributed to the stellar performance.
Construction counters are trading at an average forward PE07 of 21.8x and PE08 of 10.7x. However, most of them have December as their fiscal year-end and are currently towards the end of FY07 while CSC Holdings year-end is in March and is currently in FY08.
Given positive developments at CSC, we use a PE08 of 14x, and its diluted EPS of 3.18, to value CSC Holdings at 44.5 cts. Hence, we upgrade CSC Holdings to a BUY recommendation.
15 Nov 2007
In 1H08, revenue jumped 245% YOY to S$185m while net profit surged 296% to S$19.1m.
Strong organic growth resulting from the buoyant Singapore construction sector, coupled with the acquisition of L&M Foundation, Soil Investigation and G-Pile Sistem, contributed to the stellar performance.
Construction counters are trading at an average forward PE07 of 21.8x and PE08 of 10.7x. However, most of them have December as their fiscal year-end and are currently towards the end of FY07 while CSC Holdings year-end is in March and is currently in FY08.
Given positive developments at CSC, we use a PE08 of 14x, and its diluted EPS of 3.18, to value CSC Holdings at 44.5 cts. Hence, we upgrade CSC Holdings to a BUY recommendation.
Wednesday, November 14, 2007
BT: How much is enough for retirement?
Business Times - 14 Nov 2007
How much is enough for retirement?
By TOI SEE JONG
LIFE insurance is the cornerstone of sound financial planning to enable us and our loved ones to continue to enjoy a preferred standard of living through protection for longevity (living benefits), mortality (death benefits) and morbidity (sick or disability benefits). With the right supplement of riders to these insurance policies, other likely risks and protection needs can also be fully covered.
Retirement planning
In Singapore, those in the 30s often face conflicting and insatiable demands on their hard-earned income. The foremost priority is putting aside enough money in preparation for marriage, children and condominium (or HDB housing), a car, and club membership.
Singaporeans are among the most conscientious among Asians in purchasing protection coverage in the form of whole life or endowment plans. However, there remains a sizeable number who believe that they can sustain their living and lifestyle needs through the golden years of retirement solely on their Central Provident Fund (CPF) savings or at the appropriate time in the future in downgrading their HDB apartment to generate the necessary cashflow.
CPF causing lethargy?
Why do many Singaporeans not realise the necessity for retirement planning? That it is something to be planned proactively and provided for from a young age? It could be because many hang on to a 'make-d' attitude until the later part of their life since retirement is a long way away, or they are happy to face the situation when the time arrives.
Do Singaporeans between 55 and 60 have sufficient CPF balance? The right answer is more likely to be that many are (rightly or falsely) lulled into the belief that there is always the CPF to rely on. However, among the lower and middle classes it may be that there is insufficient CPF to tide through the entire retirement period.
Financial planning
So exactly how much is sufficient planning for retirement for an individual currently in his 30s?
The best way to ensure one has the right balance of protection and savings is to speak to a qualified financial planner to assess your financial needs. The aim is to identify the right proportion that needs to be regularly invested. For example, this could be a percentage of one's income, varying from 10 per cent to 20 per cent, depending on the individual's intended outcome and on the right combination of insurance, savings and investment plans. The aim also would be to result in retirement savings enough to afford monthly payouts after retirement equal to about two-thirds of the last drawn salary before retirement.
Why two-thirds and not the full sum? At retirement age, it is likely that the individual has paid off all mortgages, the children have completed their education and 'flown the coop'; there are no more dependent elderly parents to take care of, etc. Thus he/she may no longer need the full sum of his/her last drawn salary to enjoy the same lifestyle standards. The exact sum that an individual needs to put aside for a targeted cashflow in the future may vary from individual to individual and all depends on the financial goals.
In a 2006 Research on Protection Policies conducted by Saffron Hill Research for the Life Insurance Association of Singapore, some startling facts were laid bare:
Two-thirds of Singaporeans have some form of insurance.
Conversely, three in 10 do not have any. A lot of room for growth still.
Half of those who own insurance think they do not have enough of it
Between 15 to 30 per cent of all respondents indicated interest to buy insurance.
So how much insurance is sufficient insurance for an individual? Most who took part in the survey felt unsure about how much insurance protection is sufficient for their family. There were no clear 'formulas' to determine the right amount that is sufficient. Most take household expenses as a gauge but are unsure if this is the right measure. They also felt that their family will likely adjust their lifestyle depending on the household income.
It also seems that among those who feel they have 'sufficient' insurance cover, they estimate that between 4 to 7 times of their annual income in savings and protection is sufficient; while those who are 'well-covered' point to an insurance coverage between eight to 10 times annual income.
As a rule of thumb, when considering financial planning for the first time in your early thirties (when your commitments are still relatively low) you may want to look minimally at five to 10 times your annual income as a target to put aside in protection and savings.
Periodic review
In any financial planning, it is vital to take into account attendant and expected inflation; and cost of living increases so that there is no erosion of value on expected future benefits. A regular annual review with your financial planner is recommended. The review should take into account the most current scenario, including your current income, changes in personal or family situation and changes in planning needs.
Popular instruments
We highlight some of the key products and instruments in insurance, savings and investments available in Singapore.
Annuity
Deferred annuity offers a forced discipline to put aside a fixed lump sum now in order to receive a guaranteed monthly sum (some policies are inflation adjusted) starting from the vesting age (eg retirement age of 62 or 65) and through the rest of one's life or for a fixed period (eg 20 years) as stated in the policy purchased.
Immediate annuity on the other hand involves a fixed sum investment made immediately prior (usually a year) to retirement age, where a monthly sum is paid over the rest of the lifetime or for a fixed period (eg 20 years).
Deposits
Deposits are savings or funds placed with a financial institution over time that earns interest (simple or compounded), and is a source of preparedness for future use or in the event of emergency or periodic spending needs.
Unit trust
Unit trust allows you to invest in various funds. These funds could be invested in various financial instruments such as bonds, equities etc or a combination of them. The underlying value of the investment assets depends on the fund's objectives and the performance of those assets. For instance, a fund invested in equities may be more volatile compared to one invested in government bonds.
Investment-linked products
Following close on the heals of unit trusts are ILPs, these are similar to unit trusts, and thus allow you to invest in various funds, but they have the added feature of a life insurance cover. ILPs also allow for regular premium on top of single premium.
Insurance plans
Other common life insurance plans are term, whole life and endowment plans. Term insurance plan offers relatively high life protection (sum assured) at the lowest possible premium for a fix period. Whole life plans provide insurance coverage for the entire life. These plans would accumulate a cash value after several years (depending on the plan) and can also be a source of cash if one lives past a certain age and is prepared to draw on the cash value. Premium payments are usually for limited period or whole of life.
Endowment plans, on the other hand, offer a combination of savings and life cover. Basically it provides you cover for the duration of the plan and at the end of the term there is a savings amount payable in a lump sum. The premiums are payable for a limited period only.
Risk appetite
There are many possible combinations of protection, savings and investment plans available when looking at financial planning. There is no single one-plan-fits-all solution. Individual needs will change over the life span depending on your priorities and affordability. You should start financial planning early in life and conduct periodic reviews (perhaps as regularly as annually) to ensure optimal coverage and savings throughout your life span. Needs and expectations of lifestyle do change over time.
There is a need to proactively plan ahead for retirement, and more so to start this planning from as early as the age of 30. The best way to do this is with the help of a professional financial planner. This way you will not only have adequate protection and savings, but also the right mix of investment that would prepare you for the retirement at the age of your choice and the retirement lifestyle of your dream.
There is a sizeable proportion of the population that does not see the need for insurance and financial planning. All of us must ask ourselves the question: Do I fall into this category?
Statistics indicate that the trend is for people to continue to enjoy longer lifespan (both males and females) in Singapore. To state an example, any retirement payout plans that restrict the period to 20 years (or up to the age of 85) may not be providing for the chance that you may outlive this time horizon. If that happens you may become dependent on your loved ones.
Therefore, presently life annuities are one of the best options when planning for retirement income. One way to achieve the lifestyle of one's choice is to plan early and contribute towards a deferred annuity from an early age (say 30 years), and get a regular income of the desired amount each month after retirement.
Toi See Jong is managing director, UOB Life Assurance Limited
How much is enough for retirement?
By TOI SEE JONG
LIFE insurance is the cornerstone of sound financial planning to enable us and our loved ones to continue to enjoy a preferred standard of living through protection for longevity (living benefits), mortality (death benefits) and morbidity (sick or disability benefits). With the right supplement of riders to these insurance policies, other likely risks and protection needs can also be fully covered.
Retirement planning
In Singapore, those in the 30s often face conflicting and insatiable demands on their hard-earned income. The foremost priority is putting aside enough money in preparation for marriage, children and condominium (or HDB housing), a car, and club membership.
Singaporeans are among the most conscientious among Asians in purchasing protection coverage in the form of whole life or endowment plans. However, there remains a sizeable number who believe that they can sustain their living and lifestyle needs through the golden years of retirement solely on their Central Provident Fund (CPF) savings or at the appropriate time in the future in downgrading their HDB apartment to generate the necessary cashflow.
CPF causing lethargy?
Why do many Singaporeans not realise the necessity for retirement planning? That it is something to be planned proactively and provided for from a young age? It could be because many hang on to a 'make-d' attitude until the later part of their life since retirement is a long way away, or they are happy to face the situation when the time arrives.
Do Singaporeans between 55 and 60 have sufficient CPF balance? The right answer is more likely to be that many are (rightly or falsely) lulled into the belief that there is always the CPF to rely on. However, among the lower and middle classes it may be that there is insufficient CPF to tide through the entire retirement period.
Financial planning
So exactly how much is sufficient planning for retirement for an individual currently in his 30s?
The best way to ensure one has the right balance of protection and savings is to speak to a qualified financial planner to assess your financial needs. The aim is to identify the right proportion that needs to be regularly invested. For example, this could be a percentage of one's income, varying from 10 per cent to 20 per cent, depending on the individual's intended outcome and on the right combination of insurance, savings and investment plans. The aim also would be to result in retirement savings enough to afford monthly payouts after retirement equal to about two-thirds of the last drawn salary before retirement.
Why two-thirds and not the full sum? At retirement age, it is likely that the individual has paid off all mortgages, the children have completed their education and 'flown the coop'; there are no more dependent elderly parents to take care of, etc. Thus he/she may no longer need the full sum of his/her last drawn salary to enjoy the same lifestyle standards. The exact sum that an individual needs to put aside for a targeted cashflow in the future may vary from individual to individual and all depends on the financial goals.
In a 2006 Research on Protection Policies conducted by Saffron Hill Research for the Life Insurance Association of Singapore, some startling facts were laid bare:
Two-thirds of Singaporeans have some form of insurance.
Conversely, three in 10 do not have any. A lot of room for growth still.
Half of those who own insurance think they do not have enough of it
Between 15 to 30 per cent of all respondents indicated interest to buy insurance.
So how much insurance is sufficient insurance for an individual? Most who took part in the survey felt unsure about how much insurance protection is sufficient for their family. There were no clear 'formulas' to determine the right amount that is sufficient. Most take household expenses as a gauge but are unsure if this is the right measure. They also felt that their family will likely adjust their lifestyle depending on the household income.
It also seems that among those who feel they have 'sufficient' insurance cover, they estimate that between 4 to 7 times of their annual income in savings and protection is sufficient; while those who are 'well-covered' point to an insurance coverage between eight to 10 times annual income.
As a rule of thumb, when considering financial planning for the first time in your early thirties (when your commitments are still relatively low) you may want to look minimally at five to 10 times your annual income as a target to put aside in protection and savings.
Periodic review
In any financial planning, it is vital to take into account attendant and expected inflation; and cost of living increases so that there is no erosion of value on expected future benefits. A regular annual review with your financial planner is recommended. The review should take into account the most current scenario, including your current income, changes in personal or family situation and changes in planning needs.
Popular instruments
We highlight some of the key products and instruments in insurance, savings and investments available in Singapore.
Annuity
Deferred annuity offers a forced discipline to put aside a fixed lump sum now in order to receive a guaranteed monthly sum (some policies are inflation adjusted) starting from the vesting age (eg retirement age of 62 or 65) and through the rest of one's life or for a fixed period (eg 20 years) as stated in the policy purchased.
Immediate annuity on the other hand involves a fixed sum investment made immediately prior (usually a year) to retirement age, where a monthly sum is paid over the rest of the lifetime or for a fixed period (eg 20 years).
Deposits
Deposits are savings or funds placed with a financial institution over time that earns interest (simple or compounded), and is a source of preparedness for future use or in the event of emergency or periodic spending needs.
Unit trust
Unit trust allows you to invest in various funds. These funds could be invested in various financial instruments such as bonds, equities etc or a combination of them. The underlying value of the investment assets depends on the fund's objectives and the performance of those assets. For instance, a fund invested in equities may be more volatile compared to one invested in government bonds.
Investment-linked products
Following close on the heals of unit trusts are ILPs, these are similar to unit trusts, and thus allow you to invest in various funds, but they have the added feature of a life insurance cover. ILPs also allow for regular premium on top of single premium.
Insurance plans
Other common life insurance plans are term, whole life and endowment plans. Term insurance plan offers relatively high life protection (sum assured) at the lowest possible premium for a fix period. Whole life plans provide insurance coverage for the entire life. These plans would accumulate a cash value after several years (depending on the plan) and can also be a source of cash if one lives past a certain age and is prepared to draw on the cash value. Premium payments are usually for limited period or whole of life.
Endowment plans, on the other hand, offer a combination of savings and life cover. Basically it provides you cover for the duration of the plan and at the end of the term there is a savings amount payable in a lump sum. The premiums are payable for a limited period only.
Risk appetite
There are many possible combinations of protection, savings and investment plans available when looking at financial planning. There is no single one-plan-fits-all solution. Individual needs will change over the life span depending on your priorities and affordability. You should start financial planning early in life and conduct periodic reviews (perhaps as regularly as annually) to ensure optimal coverage and savings throughout your life span. Needs and expectations of lifestyle do change over time.
There is a need to proactively plan ahead for retirement, and more so to start this planning from as early as the age of 30. The best way to do this is with the help of a professional financial planner. This way you will not only have adequate protection and savings, but also the right mix of investment that would prepare you for the retirement at the age of your choice and the retirement lifestyle of your dream.
There is a sizeable proportion of the population that does not see the need for insurance and financial planning. All of us must ask ourselves the question: Do I fall into this category?
Statistics indicate that the trend is for people to continue to enjoy longer lifespan (both males and females) in Singapore. To state an example, any retirement payout plans that restrict the period to 20 years (or up to the age of 85) may not be providing for the chance that you may outlive this time horizon. If that happens you may become dependent on your loved ones.
Therefore, presently life annuities are one of the best options when planning for retirement income. One way to achieve the lifestyle of one's choice is to plan early and contribute towards a deferred annuity from an early age (say 30 years), and get a regular income of the desired amount each month after retirement.
Toi See Jong is managing director, UOB Life Assurance Limited
BT: Time to redraw your retirement plan
Business Times - 14 Nov 2007
Time to redraw your retirement plan
Longer life expectancy and erosion of traditional pension schemes signal that retirees may outlive their assets, says KURT REIMAN
RETIREMENTS are becoming ever longer and more costly. Pensioners need to save enough to fund a comfortable life and to ensure they can leave assets to the next generation.
Retirement, in its current form, will soon be a thing of the past as demographic, financial and lifestyle factors lay siege to the traditional models. Pension plans, both public and private, face a squeeze from fewer people working and more people retiring. Meanwhile, medical and healthcare spending are rising, putting government finances under additional strain.
Yet most people expect to lead active and healthy lives during retirement, with some hoping to combine relaxation with a job, part-time or otherwise. Together, these trends are reshaping our thinking about careers and how to pay for what comes afterwards. Retirement, in short, is evolving into something completely new.
Traditionally - and particularly in places other than Singapore - retirees have relied primarily on government and corporate pension plans and think of their personal savings as an extra resource for additional or unforeseen expenditure. But the health of state-run pension programmes is under scrutiny, forcing individuals to take more responsibility for their well-being in old age. Against this background, living too long and spending too much have emerged as major risk factors. The latter hazard is accentuated by the ever more active lifestyle of senior citizens. If enterprising and adventurous pensioners want to enjoy their third age to the full, however, they need to ensure that their assets will stay the course.
Will I outlive my assets?
According to the United Nations, people born today in developed countries can expect to live 75.6 years on average, up from 66.1 years for those born in the 1950s. Moreover, today's 60-year-olds can expect to live even longer than these statistics suggest, having survived the high risk periods of infancy and early youth. Indeed, they might well live another twenty years on average, and this life expectancy continues to lengthen (see Figure 1).
Longer lives and the erosion of traditional pension schemes add to the danger that retirees will simply outlive their assets. So does the fact that life expectancy estimates have often erred on the low side in the past: that is, people have tended to live far longer than the statisticians have predicted.
All this increases the uncertainty surrounding the key question - how long they will live - that individuals need in planning for retirement. Nor do life expectancy forecasts account for the important differences stemming from gender, status, occupation, educational attainment, and country of residence.
If they rely on average life expectancy statistics, five people out of 10 run the risk of living longer than their assets will last. To mitigate that risk while they are still earning and saving money, investors would be best advised to calculate their retirement horizon conservatively (that is, by assuming a rather high life expectancy).
At the same time, they should factor in any relevant variables such as their physical condition and family medical history. A realistic perspective on one's personal life expectancy can go a long way to mitigating longevity risk.
Once they have accumulated the assets which will pay for their retirement, investors can also reduce that risk by purchasing an annuity, which comprises a series of payments of set size and frequency during the life of the holder. Although annuities are not risk-free - they are, for example, exposed to the hazards of inflation or the failure of the providing institution - they do ensure a constant nominal income stream regardless of how long the holder lives.
Demand for such instruments is on the increase as pension schemes become less generous. However, the amount of money that should be invested in an annuity remains a highly personal choice and it should always be borne in mind that committing assets to an annuity can reduce the amount of a portfolio that can be passed on to the next generation.
Will I overspend my assets?
The danger that one might live beyond one's means, also known as liability risk, is another increasingly relevant factor in retirement planning. It is linked to the fact that people are living longer and arises partly from the trend towards increased individual responsibility for healthcare. Additional factors include the growing taste for more ambitious lifestyle goals, such as frequent travel and staying young and fit.
There are numerous ways to reduce liability risk. One can continue to work longer or relocate to a country with a lower cost of living (see Figure 2). This also helps to reduce the chance that you will live longer than your assets last. Each extra year of spending that is funded from employment income represents an additional year that retirement withdrawals can be postponed and investments can continue to grow.
Another option is to limit the uncertainty related to future costs by purchasing elderly and long-term healthcare insurance. Without this insurance, individuals may need to plan for worst-case scenarios for healthcare liabilities, or face the prospect that healthcare costs will erode assets that would otherwise be passed on to the next generation. Individuals can also pay down debt before they retire in order to increase their net worth.
Mandatory v discretionary
needs When it comes to reckoning up the total income a retiree will need, expenses should be classified into mandatory and discretionary. Mandatory expenses are those related to basic daily needs, including housing (mortgages, taxes, and maintenance fees), food, and medical care.
Discretionary expenses are everything else, accounting for the remainder of the total income requirement.
To estimate how much income you might need, consider the things that you really cannot do without and the things you might be able to sacrifice or scale down. An apartment, for example, might be more convenient and cheaper than maintaining a house, and holidays at home might be less costly than travelling. Downsizing your lifestyle might be an option if you fear that your assets might melt away too soon. A solid estimate of your mandatory needs also helps you to determine the amount of assets that should be invested in an annuity, if any.
Figure 3 shows a hypothetical income and expense framework during retirement. Mandatory expenses are met with pension and annuity income, while discretionary needs are funded by assets allocated first to an absolute return portfolio. Other discretionary income sources could also include rental income, royalty payments, or other alternative income streams. Assets above and beyond these mandates are contained in a growth portfolio, which can be allocated in line with investors' longer-term goals.
When there is a high probability or desire to leave a bequest, assets can be allocated with the beneficiaries' time horizon in mind. Consider also that bequest motives require prudent estate planning; holding rapidly appreciating assets can significantly increase estate tax liability.
Review regularly
No estimate or forecast can be safely relied upon unless it is regularly reviewed in the light of changing economic, financial, regulatory, demographic, and personal circumstances. Without such a review, even the most finely tuned income scheme may quickly lose its relevance. It is important to keep track of realized investment returns, as well as expenditure, and to adjust spending habits and lifestyle as necessary. Retirees should, therefore, review their retirement plans regularly and discuss their plans with their client advisers.
Kurt Reiman is head of thematic research at UBS Wealth Management Research. He can be contacted at kurt.reiman@ubs.com
BT: Tactical asset allocation models cut risks
Business Times - 14 Nov 2007
Tactical asset allocation models cut risks
ARJUNA MAHENDRAN examines the use of total return strategies as a way of riding out turbulent stock markets
THE stock market boom that started back in 2003 is expected to continue in the medium term. However, an analysis of longer-term market cycles shows that equity investors must brace themselves for more volatility in the short term.
Historically, bull markets have been spread over several decades. Examples of this are the sustained boom that followed the US Civil War and lasted until the beginning of the 20th century, the period after World War II to the end of the 1960s, as well as the phase from the beginning of the 1980s until the Internet bubble burst in 2000. These boom phases were all driven by fundamental innovations such as the railway, electricity, automobiles, aviation, and modern telecommunications.
By contrast, bear markets - when equity prices tumble as they did in 2000-2003 - tend to last two to three years, and result in cumulative losses of between 40 per cent and 80 per cent.
They historically turn into a new bull phase with relatively small and mild corrections in the first four to six years, the most recent of these periods probably being from 2003 to mid-2007. The second phase of a long-lasting bull market usually sees a correction of 15-20 per cent before the boom continues.
The current economic and societal changes clearly indicate the continuation of the bull market. New technologies (digital communication, nanotechnology), the rapid industrialisation of emerging markets such as China, and demographic changes (urbanisation in Asia, ageing populations in many industrialised countries) provide favourable conditions for growth.
However, concerns about dwindling energy resources, geopolitical tensions and environmental problems mean that it will not all be smooth sailing.
Investment strategies must, therefore, also factor in potential crises. In the current environment, the question is whether investors should adopt a passive strategy. Too much short-term switching in a portfolio will eat into returns, but a purely passive strategy when prices are falling could also lead to (book) losses of between 40 per cent and 80 per cent over several years.
Between 1926 and 2006, it sometimes took more than 20 years to earn a higher annualised return on Swiss equities than on Swiss bonds. The figures for the US tell a similar story. In the long run, equity investors are the most successful, but at the same time are exposed to considerable fluctuations in value. Investors with a strong stomach and the courage to buy in weak market phases can achieve handsome returns.
But the loss risk that comes from buying near the end of a boom phase should not be under-estimated. The markets are prone to exaggeration: One of the best-known examples is the equity and property bubble in Japan at the end of the 1980s when the Imperial Palace in Tokyo was estimated to be worth as much as the whole of California. Or the technology and Internet bubble in 2000 which saw breathtaking leaps in the market capitalisation of companies that often did not turn a profit and in some cases did not even report any turnover.
Our analyses show that simple indicators such as seasonality (sell in May and go away), momentum, central bank monetary policy, and interest-rate structures on the capital markets can be a useful source of investment tips. A combination of these factors has led to higher returns with a lower downside risk.
These results suggest that sophisticated tactical asset allocation models can offer attractive returns while at the same time substantially reducing the loss risk, otherwise known as total return strategies. Total return, or absolute return, strategies have two objectives: to achieve a minimum return, often equal to the money market return plus 2-3 per cent; and at the same time to minimise the loss risk. Most of these strategies aim to generate a positive return over a 12-month period.
Total return strategies draw on a dynamic investment approach and diversification to reach their objectives. Demand for these strategies tends to increase when the markets become volatile.
Relative return strategies, by contrast, track their performance against a benchmark. This approach means that fund managers can beat the benchmark despite making net losses for their clients, for example, if the fund loses 12 per cent but the benchmark index falls 20 per cent.
The situation is reversed if the total return strategy achieves 10 per cent while the equity market gains 20 per cent in a given year. Investors must be aware that it is not only the returns that vary; the risks are also different.
In practice, total return and relative return strategies are not mutually exclusive. Many clients want active risk monitoring for part of their investments, but at the same time are mindful of the returns achieved in relation to traditional investment forms such as equities and bonds.
Arjuna Mahendran is chief economist and strategist, Asia-Pacific, Credit Suisse Private Banking
Tactical asset allocation models cut risks
ARJUNA MAHENDRAN examines the use of total return strategies as a way of riding out turbulent stock markets
THE stock market boom that started back in 2003 is expected to continue in the medium term. However, an analysis of longer-term market cycles shows that equity investors must brace themselves for more volatility in the short term.
Historically, bull markets have been spread over several decades. Examples of this are the sustained boom that followed the US Civil War and lasted until the beginning of the 20th century, the period after World War II to the end of the 1960s, as well as the phase from the beginning of the 1980s until the Internet bubble burst in 2000. These boom phases were all driven by fundamental innovations such as the railway, electricity, automobiles, aviation, and modern telecommunications.
By contrast, bear markets - when equity prices tumble as they did in 2000-2003 - tend to last two to three years, and result in cumulative losses of between 40 per cent and 80 per cent.
They historically turn into a new bull phase with relatively small and mild corrections in the first four to six years, the most recent of these periods probably being from 2003 to mid-2007. The second phase of a long-lasting bull market usually sees a correction of 15-20 per cent before the boom continues.
The current economic and societal changes clearly indicate the continuation of the bull market. New technologies (digital communication, nanotechnology), the rapid industrialisation of emerging markets such as China, and demographic changes (urbanisation in Asia, ageing populations in many industrialised countries) provide favourable conditions for growth.
However, concerns about dwindling energy resources, geopolitical tensions and environmental problems mean that it will not all be smooth sailing.
Investment strategies must, therefore, also factor in potential crises. In the current environment, the question is whether investors should adopt a passive strategy. Too much short-term switching in a portfolio will eat into returns, but a purely passive strategy when prices are falling could also lead to (book) losses of between 40 per cent and 80 per cent over several years.
Between 1926 and 2006, it sometimes took more than 20 years to earn a higher annualised return on Swiss equities than on Swiss bonds. The figures for the US tell a similar story. In the long run, equity investors are the most successful, but at the same time are exposed to considerable fluctuations in value. Investors with a strong stomach and the courage to buy in weak market phases can achieve handsome returns.
But the loss risk that comes from buying near the end of a boom phase should not be under-estimated. The markets are prone to exaggeration: One of the best-known examples is the equity and property bubble in Japan at the end of the 1980s when the Imperial Palace in Tokyo was estimated to be worth as much as the whole of California. Or the technology and Internet bubble in 2000 which saw breathtaking leaps in the market capitalisation of companies that often did not turn a profit and in some cases did not even report any turnover.
Our analyses show that simple indicators such as seasonality (sell in May and go away), momentum, central bank monetary policy, and interest-rate structures on the capital markets can be a useful source of investment tips. A combination of these factors has led to higher returns with a lower downside risk.
These results suggest that sophisticated tactical asset allocation models can offer attractive returns while at the same time substantially reducing the loss risk, otherwise known as total return strategies. Total return, or absolute return, strategies have two objectives: to achieve a minimum return, often equal to the money market return plus 2-3 per cent; and at the same time to minimise the loss risk. Most of these strategies aim to generate a positive return over a 12-month period.
Total return strategies draw on a dynamic investment approach and diversification to reach their objectives. Demand for these strategies tends to increase when the markets become volatile.
Relative return strategies, by contrast, track their performance against a benchmark. This approach means that fund managers can beat the benchmark despite making net losses for their clients, for example, if the fund loses 12 per cent but the benchmark index falls 20 per cent.
The situation is reversed if the total return strategy achieves 10 per cent while the equity market gains 20 per cent in a given year. Investors must be aware that it is not only the returns that vary; the risks are also different.
In practice, total return and relative return strategies are not mutually exclusive. Many clients want active risk monitoring for part of their investments, but at the same time are mindful of the returns achieved in relation to traditional investment forms such as equities and bonds.
Arjuna Mahendran is chief economist and strategist, Asia-Pacific, Credit Suisse Private Banking
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