Friday, June 06, 2014

The holy trinity of returns, risk and liquidity

There's been much talk about the CPF rates being very low. About 2.5 to 4% depending on which account you're talking about. It's kind of hard to get higher returns than that while maintaining the same risk as that of a fixed deposit. What risk am I talking about here? It's the risk of capital losses. And I'm not just regurgitating this - I've actual experience in maintaining a retirement fund for my parents, so I know what I'm talking about here.

My parents are not risk takers. The riskiest kind of investment product that had in the past (without losing money) are endowment funds from some insurance companies. You put in a lump sum at the start and wait for the term to mature, then you take out a sum greater than the lump sum you put in at the beginning while still giving you assurance that if anything goes wrong with you, you'll still get paid when it matures - that's basically how endowment plan works. This tranche of money that my parents had, they initially wanted to put in a fixed deposit offering maybe 1.2 to 1.3%. I thought I can do better than that, and offered to give them a higher return and also offer them capital guarantee too but they have to tell me a few months in advance if they need the money back. In other words, they are buying a bond from me, with me as the party guaranteeing that amount invested with flexible maturity date.

The magical point of all portfolio - to balance returns, risk and liquidity. Can't have it all.

The portfolio consists of preference shares from banks and some high grade bonds with strong corporate (and government backing, so they say). No equities at all because given my parent's requirements (they really just want their initial capital to be safe and liquid). How's the projected returns? It is expected to give around 3.6%, with capital losses incorporated (Most of the pref shares and bonds are bought above par from the secondary market at SGX, so when it's recalled back, I'll lose some capital). Can I push it above 3.6%? Yes, but something will have to go. The risk of capital losses increases with the portfolio yield. I can get some very high yield bond (e.g. from Olam) but if something happens, I'm the one bearing the losses because I'm the guarantor. Bo hua for me.

So yes, I totally get it that if CPF returns is 6 to 8% pa, then it can't be capital guaranteed. We have to balance portfolio returns, risk and also liquidity and you just can't have it all.

But not easy doesn't mean that CPF board should take the easy way out to beat inflation by raising the minimum sum. I think more options can be given to CPF holders to participate in the growth of their retirement funds. I would really be happy to see more growth in the bonds market offered to retail investors. If you're talking about normal bonds, you need at least a quarter of a million to participate - and how many people has that kind of money to spare? If SGX can break up the size of the offer into smaller chunks (in 1k lot, for example), it'll be a great move towards helping retail investors adjust their respective portfolio returns with the risk of capital loss.

More selfishly, I think it'll be good for people who don't have CPF (like me) to plan their retirement funds their own way.


Patrick T. said...

Just curious - did you parents pledge their property to CPF in order to reduce their minimum sum?

I am going to do that soon...

la papillion said...

Hi patty,

Nope, I don't think they did. They had already finish paying for their housing and there's not much CPF for them. They are like me, self employed for most of their lives. Except for my father who had worked in a company for a while, they don't contribute to CPF, so they don't have much to withdraw anyway.

You're going to help your parents pledge their flat?

Patrick T. said...

I will be asking my parents about it but I am doing it for my own account mainly. You know me... While I have my reservations about the system, I also find ways to play the game well?

Pledging property against CPF will reduce the minimum sum by up to 50℅, funds I know I can put to better use elsewhere...

la papillion said...

Hi Patty,

Hmm, you're a bit too early to pledge right? You're still far from the withdrawal age so who knows what kind of new rules will appear between now and then.

Patrick T. said...

It's not early as I want to use CPF to pay for the 2nd property - it requires 50% MS to be set aside before you can utilize any more. I can do with setting aside only 50% of 50%. :)

la papillion said...

Hi Patty,

Wow, I think you need to educate me on this..tell me about your plans :)