Thursday, March 22, 2007

1st April 2007 - a better april fool for us

is it a sign that election is coming soon in Malaysia? who knows? but today...

Bank Negara (Central Bank of Malaysia) has announced further liberalisation of our foreign exchange administration. Previously, as an individual, we only can invest up to RM 100k abroad per annum...now, RM 1 million! bravo! but seems like it has nothing to do with me...

Limits for Corporation for overseas investment has increased to RM50million p.a. from RM10million p.a. before... good stuff, shall we expect to see more growth in earnings in coming years or more volatility in their earnings? well, in the end of day, it's fundamental that counts. Company with good management team will always outperform the rest...

Onshore funds like Unit Trust, Fund Management and Insurance companies can now invest up to 50% of their Net Asset Value (NAV) in foreign currency assets from 30% previously. This is good news for investors as you will expect fund houses and insurance company will continue to roll out more innovative product for us to invest in overseas, thus better diversification i would say.

there are more details to it, but bottom line is, we're on our way back to the open market that we used to be in before the Asian Crisis 1997. Most importantly, foreign investors will regain their confidence in our market again!

but then, there was an argument saying that it might not be such a good idea as investment flow might flow out faster that usual as previous "liquidity trap" in the market has loosened up abit... oh well... what ever it is, if you believe in economic theory, an economy with no government intervention or any form of capital control is the best form of market, as dead weight loss will be minimize, more efficient allocation of assets.... etc etc

This relaxation will officially be effective on....1st April 2007.

if you think this piece of news is not good enough. wait, we have more!

The government has announced several incentives to boost the property market, but most exciting of all, is this.

The Abolishment of nationwide REAL PROPERTY GAINS tax with effect from...1st April 2007!

what does this mean?

it means that if you have recently bought a house, you can straight away sell it off, with no property gain tax! (of course, provided you make a gain...) or, if you think this property can make money, but you have not enough capital, plus you don't want to stay there...you can borrow from bank, buy the property, and "flip" it within months, sell it at a gain, and hey ! no property gain tax!

by no mean, for foreigners and those who leaving the countries for good, this sounds like a good way to make more profit on the way out...

but would this induce to a mini-version of US Housing crisis? when there's too much flipping in the property market wouldn't it leads us to the same collapse that happened in Hong Kong's property market as well?

well, oh well, it's a good news, so at the mean time, we should embrace it happily. Who knows what lies in the future?

hopefully, this is a good April fool gift.

Thursday, March 15, 2007

Behavioural Finance - the answers...

In my previous entry, i've posted a question developed by Kahneman & Tversky. Here's the question again:-

#Choose 1 from (a) (b) and 1 from (c) (d) the following

(a) A sure chance of getting $2,400, or
(b) A 25% chance of getting $10,000 and a 75% chance of getting nothing.

(c) A sure chance of losing $7,500, or
(d) A 25% chance of losing nothing and a 75% chance of losing $10,000 #

Ok, generally, normal people, like you and me will choose (a) and (d). Why?

The efficient market theory assumes that all investors are Rational, i.e. we will always allocate our assets according to Expected Return and Risks. A rational investor will always go for the asset with the highest expected return, at a given level or risk, or invest in the asset with the lowest level of risk, at a given level of expected return. That's the theory.

In reality, we're no where near that. We are rather emotional. Ok, back to the question. Why choose (a) over (b)?

We will generally choose (a) because (a) gives you a 100% chance of receiving $2,400 bucks! A windfall! Whereas in (b), you have to gamble for it. So your mind has already been anchored that you can get $2,400 for sure, why gamble for it? But, in terms of finance, the way we generally look at it is through the calculation of Expected Return.

In (a), the expected return is $2,400.
In (b), the expected return is [0.25 x $10,000] + [0.75 x $0] = $2,500

Since (b) has the higher expected return comparing to (a), (b) should be chosen instead!

Ok, how about (c) and (d)?

Most people, including myself, Hate Losing. Let it be sports, card games, in relationship & investing, we dislike losing. Most people will choose (d) over (c), why?

Basically, (c) tells you, “You are a confirm loser. Pay me $7,500 now!” This is painful. (Both emotionally and financially)
So you say, “Hey, I am not a loser, I will choose (d) and I am not going down without fighting!”

Some academics say investors always believe too much in his/herself, i.e. Over-confidence. Oh well, we will eventually be humbled by the market…

Anyway, so you chose (d). Let’s do some calculation.

In (c), the expected return is -$7,500
In (d), the expected return is [0.25 x $0] + [0.75 x -$10,000] = -$7,500

Well, in this case, a rational investor should be indifferent between (c) and (d), but of course in reality, most of us hate losing and always over-confident that we might be lucky this time, (d) will be the favourite for sure.

So, if I combine all four of them together, which two is the best combination?

Let’s start with combination (a) & (d), the top picks by most people. The total expected return is

E(R) = [1 x $2,400] + [0.25 x $0] + [0.75 x -$10,000] = a loss of $5,100. Ouch!

According to Kahneman & Tversky, the optimal combination is (b) & (c) [or (d)]!

Here’s the expected return

E(R) = [0.25 x $10,000] + [0.75 x $0] + [-$7,500] = a loss of $5,000, effectively $100 better off than the (a) & (d) combination.

So what does this tell us?

Most people, like you and me, have mind-framing in our decision making process. We always differentiate the decision making process of “realizing gains” & “realizing loss”. In terms of gain, we always want the safest bet, unless, you have some buffer to gamble. Whereas, for loss, we prefer to gamble, and who knows, we might be lucky and can get away with lesser losses?

We rarely combine those two decisions together, although we should.

That’s the mentality of general investors ;)

Monday, March 12, 2007

Plankton Theory

read an interesting theory by Bill Gross, the bond king, who manages the world biggest bond fund at PIMCO, re-quoted by Paul McCulley at his Global Central Bank Focus dated March 2007. Bill Gross first wrote this Plankton Theory way back in August 1980.

"The plankton theory, like life itself, begins and ends in the ocean. Plankton, of course, are almost microscopic organisms that serve as food for higher life forms. Without plankton almost every fish and mammal in the sea could not survive, since most species depend upon other fish for their existence and plankton are the initial building blocks of the entire process ... ... In the case of real estate, the plankton would be the first time buyer (perhaps a young married couple) with a desire to own their own home but with very little capital to carry it off. When the time comes that they can't pull it off ... then the plankton would disappear and the rapid escalation in housing prices would ease as well. For, unless the current homeowner has someone to sell his house to, he'll be unable to afford the house, and the process would continue into the echelons of Beverly Hills and Shaker Heights. In the end, the entire market would wither on the investment vine and home prices would stop increasing at the same rapid rate. So to gauge the health of the housing market, look first at the plankton. Without their presence and financial vitality, the market's not going to repeat the experience of the past 10 years."

The meltdown in the US Sub-prime mortgage market has always been the talk in town and US housing woe has always been highlighted by financial gurus around the world as the key factor to cause the global financial crisis. Plankton theory, helps us to understand that a building won't be standing tall and remained stable if the foundation has weakened substantially. However, for us not in the US, it's pretty hard for us to see if the "planktons" are dying. However, we could look at some US economic data more closely in order for us to prepare for the "next worst thing".

If housing is the main "theme" last year, this year, US Unemployment figure will be an exciting one.

Perhaps it's time to watch out.

Word of wisdom:

"I will tell you how to become rich. Close the doors. Be fearful when others are greedy. Be greedy when others are fearful" - Warren Buffet.

"Investing is simple, but not easy." - Warren Buffet.