What You See Is What You Get? II

When mutual fund (unit trust) shows its performance, it is in Bid-to-Bid performance. For example, when it shows 10% return per annum, it indicates 10% return per annum of its Bid Price, ie: Bid Price on 2nd January 2007 is $ 1.10 as compared to Bid Price on 2nd January 2006 of $1. Bear in mind that return on Bid-to-Bid is NOT Return On Investment (ROI) of the unit holders. Let’s consider 10% Compounded Annual Growth Rate (CAGR) where Fund KSA managed to achieve for 5 years, what will the investors get if he decide to cash out at the end of 5years:

Year OP ($) BP ($) BP-BP (%) ROI (%) Diff (%)
0 1.0000 0.935 0 0 0
1 1.0835 1.0131 8.35 -5.28 NA
2 1.1740 1.0977 17.38 2.63 561.09
3 1.2720 1.1893 27.20 11.20 142.83
4 1.3782 1.2886 37.82 20.49 84.61
5 1.4933 1.3962 49.33 30.55 61.48



John invested $ 10,000 at the beginning of 5 years period. He does not cash out until the end of the period and at the same time, he reinvested all dividends. After 5 years period, Fund KSA announces that it achieves 49.33% return (that is in term of Bid-to-Bid). When John sold all his units, he found out that he only manage to get $ 13,055 (1.3962 * 9,350 units) instead of $ 14,933. His real Return On Investment (ROI) in term of investor’s perspective is 30.55% instead of 49.33%, which is 61.48% difference. You might ask where is the money gone? Remember, there is always costs involved to feed the interested parties, ie: 6.5% Sales Load and 1.5% Annual Management Fee.

What You See Is What You Get? I

Whenever someone makes an investment, being it in equities, mutual fund (unit trust), real estate and so forth, his objective is to maximize his Return On Investment (ROI). In Mutual Fund, a conventional belief of its return is around 12% per annum. An outcome of the investment return will varied depends on different strategies employed by the investors. Bear in mind that in mutual fund investment, there are 2 typical charges, ie: Sales Load which hover around 5 to 6.5% and Annual Management Fee at 1.5%. Whenever we look at the table of the mutual fund, there would be 3 columns, which are Offer Price (OP), Bid Price (BP) and Net Asset Value (NAV). The difference between OP and BP constitute Sales Load. To make a picture clearer, let’s show you an example.

John invested $ 10,000 in Fund KSA on 2nd January 2006 at OP of $1. With this, he will have 9,350 units of the fund (Note: 6.5% Sales Load). After a year, Fund KSA OP is at $ 1.20. At a glance, it shows a return of 20% per annum. Quite impressive with this return rate. If he sold all of his 9,350 units, he will get $ 10,333 (9,350 * $ 1.10517). Instead of the 20% return, he only manages to get the return rate of 3.33% of his original investment. Playing magic, huh? Sometimes, what you see is NOT what you get….

Dollar Cost Averaging (DCA)?

DCA gains its popularity especially by the mutual fund (unit trust) investors since it is promoted by the interested parties. What is DCA? One might ask. It is a systematic and regular investment of a fixed amount of money regardless of the price level, meaning that it does not bother the up and down of the market. Investor will get more units when prices are down and fewer units when prices are up.

The promoters claim that by adopting this system, it will reduce investment risk because the risk already averaging out. The most wonderful thing is it needs not your close monitoring to the market. Sound simple and great, isn’t it?

Before we jump into a conclusion whether DCA is practical is a real world or not. Let’s examine what’s your reaction for this scenario:

There are 10 different stalls selling local cuisine. You are having your dinner every evening and you have a freedom to choose which stall you will have your dinner. From the beginning, you might rotate your dinner among these stalls because you want to try something new and you want to know which is the best. After a while, you know exactly Johnny Stall is the best with a reasonable price tag at $ 10 for a dinner. You do not choose others because you know well that for some stalls, the foods might not fresh, the cleanliness of the stalls is not accepted and so forth. Thus, you will go to Johnny Stall for your dinner every evening.



One day, as regular as your previous evenings, you have your dinner in Johnny Stall. After dinner, you pull out $ 10 for the bill. Surprisingly, Johnny presents the bill with a price tag of $ 20! Being curious you ask him the reason. He answer: “I’m not in the good mood today.”

The next day, you go to the same stall and after a dinner, you pull out $ 20 for a bill. This time, Johnny only charges you $ 5.

After several times, you know well that Johnny stall’s dinner is the best and the quality remain the same. The only difference is its bill – it depends to the mood of Johnny. In bad mood times, he would charge you above fair value of $ 10 which can be as high as $ 20. While in his good mood times, he would present you with a same quality dinner but in discounted price, could be as low as $ 5. You need not be a rocket scientist to know when is the best time to have your dinner, don’t you?

We need to have a dinner every evening and thus we have no choice to pay for the bill asked by Johnny. But, for a rational intelligent investor, there is no timeframe for him to invest. It could be no investment made at all for the entire 5 years and when opportunities arise, there could be 5 or more investments made in a year. It all depends to the market – Market is your servant, do not reverse it.



By adopting DCA, it is just insane to invest in whatever price tag. When in real life, you definitely would not buy something when the price tag is far beyond a fair value, will you do it in your investment? When promoters claim that by adopting DCA, it reduces investment risk, so does the return rate of the investment result.

Oasis of Eternity -- Michelangelo 3: Sistine Chapel Ceiling

The paintings on the ceiling of Sistine Chapel were done by Michelangelo from 1508 to 1512. The paintings include 9 scenes from the Book of Genesis, the order of the scenes from the altar towards the main entrance:

1. The Separation of Light and Dark
2. The Creation of the Sun, Moon, and Planets
3. The Separation of Land and Water



4. The Creation of Adam
5. The Creation of Eve
6. The Temptation and Expulsion



7. The Sacrifice of Noah
8. The Flood
9. Drunkenness of Noah

Oasis of Eternity – Michelangelo 2: The Creation of Adam

The painting is done by Michelangelo in 1511 on the ceiling of Sistine Chapel, Vatican City, Rome. Eve, appeared in Adam's left leg. Besides his expertise in arts, his human anatomy’s knowledge could not be under estimate. In 1990, a physician named Frank Lynn Meshberger noted that the background figures and shapes portrayed behind the God appeared to be an anatomically accurate picture of the human brain, including the frontal lobe, optic chiasm, brain stem, pituitary gland and the major sulci of the cerebrum. Also, the red cloth around the God has the shape of human uterus and the green scarf hanging could be a cut umbilical cord.

Mutual Funds Hopper

In the job market, the objective of a job hopper is to gain more benefits compared to his previous job. Will he achieves his objective? It depends to his luck as well as his capability. How about mutual funds’ holders? Very frequent, either by his own judgment or persuasion from the interested parties, the holder changes his portfolio from Fund A to Fund B and so forth. The objective is similar: to gain more. But, will he achieve his? The answer: SURE LOSE GAME.

The answer is very obvious since there are underlying costs involved in the mutual funds, ie: Sales load and annual management fee.



Take one example: Johnny invests $ 10,000 by his own for the beginning and let the capital and its return compounded yearly. The investment return is 10% per annum. What he gets after 30 years patience? $ 174,494. How about Ken who also invests $ 10,000 in mutual funds for the beginning with same return rate but he changes his portfolio every year, meaning that in 1st year, he is in Fund A, 2nd year in Fund B, 3rd year in Fund C and so forth? Waiting patiently for 30 years as Johnny, what will he gets? $ 23,234!! That is a difference of $ 151,260 or 651%!! The more or longer Ken invests, the more he loose out from the game.

Why there is so much difference? That’s because of Sales load imposed by Mutual Fund to its holders. The Sales load is ranged from 5 to 6.5%. Its existence is to channel to its promoters, so that the promoters can put efforts to sell the products. Remember whenever you intend to purchase mutual funds, there are flocks of difference salesmen come to your place and tell you their funds are the best and persuade you to invest on them? That’s the cost of doing business – there is no free lunch in this world. If there is no incentives for these promoters, who will sell hardly for the fund?

Bear in mind in the example given, we do not include a typical 1.5% annual management fee. If we add it into the example, the difference will be larger.

Oasis of Eternity -- Michelangelo 1: The Last Judgement Day

The picture (1537-41) is a masterpiece of Michelangelo on the ceiling and altar wall of Sistine Chapel, Vatican City, Rome. The artist's self-portrait appears twice in the picture: in the flayed skin with Saint Bartholomew is carrying in his left-hand, and in the figure in the lower left hand corner, who is looking encouragingly at those rising from their grave.

Mutual Funds @ Super Highway

Article by Louis Lowenstein about the turnover rate of the mutual funds (unit trust).

Have you ever care about how fast your fund managers changing their portfolio? The answer? 100% and for some even as high as 305% per year!! What is this means? That means holding period of the portfolio is less than a year (100% per year) or less than 4 months (305% per year)!! While purchasing the fund, the promoters always tell you “invest for long term”, at the same time, they are doing the reverse. “Long term” by their definition seems less than a year from their action.

In any business, a period of a year seldom gives you a clear picture of how a company performs. In such a short period, very often the performance of the company is merely a luck. If the company delivers a handsome result this year, you can’t just assume the same result will repeat for next years. For example, in 2004, steel production companies enjoyed a handsome result but the reverse happened in 2005.



The high rate of portfolio turnover by fund managers only indicates their speculative mentality. They try to time the market and most often they are wrong. When the management fee is tied to the size of the fund and their net worth is not tied to the fund they manage, there is no wonder why irresponsible action occurs.

The funds managed by managers with speculative mentality would only deliver a poor result to their fund holders. The result could be as wide as 18% per year over the period of 5 years as compared to value-oriented funds. With compounded effect, if you invest $ 10,000 and the difference is 18% per year, see the difference:

Year Value Fund Speed Fund Difference (%)
0 10,000 10,000 0
5 22,878 10,000 129
10 52,338 10,000 423
20 273,930 10,000 2,639
30 1,433,706 10,000 14,237

Will you invest in Speed Fund anymore??

Warren Buffett: The Man

Warren Buffett with Cahrlie Rose Interview:
1) Part I
2) Part II
3) Part III

Very interesting topics mentioned by a philanthropic billionaire.

Joan Miro

Dona i ocell (Woman and bird) in Parc de l'Escorxador, Barcelona by Joan Miro. He is one of the famous Catalan artists in Barcelona whose among others include Antoni Gaudi, Salvador Dali and Pablo Picasso. There is a museum of his works located in Montjuic Hill, not far from here.

Illusion of Focus

Question:
1) How many legs do the elephant have in Picture A?

2) In Picture B, focus your concentration into the cross. After few seconds, what would you discover?

3) What can you see in Picture C and Picture D?

4) Assuming the dog tail is a leg, how many legs does the dog have?

Answer:
1) 4
2) Some red dots disappear
3) In Picture C, there are 2 words: You and Me; In Picture D, the 2 words are: Teach and Learn
4) 4. No matter what the assumption you make, a tail still a tail, it would not change to a leg as you assume.

There are too many illusions in the world making us losing our concentration. For example, CEO of Company ABC in his prospectus will project his company will have net earnings of $ 100 million in the coming year. Before he ends his words, he will add: “Barring unfavorable circumstances, the projection made is based on the assumption of bla bla bla…..”. Remember the lesson you learn from the Question 4? “A tail will still remain a tail, no matter what the assumption you make.” Similarly, a stone remain a stone, it would not change because you assume it is a gold.

Conclusion:
Stay focus on your concentration!!

Preview: Oasis of Eternity -- Michelangelo

Berkshire's 40 Years Wisdom of Life 8: Diversification

"If only one variable is key to a decision, and the variable has a 90% chance of going your way, the chance for a successful outcome is obviously 90%. But if ten independent variables need to break favorably for a successful result, and each has a 90% probability of success, the likelihood of having a winner is only 35%." -- Warren Buffett, Letter To Shareholders, Berkshire Hathaway Inc., 2004.

Note: Given the chance, will you bet for the of winning with probability of 0.9 or 0.35? Put all the eggs in a basket after you study throughly realiability of the basket is always better than distribute the eggs into 10 different baskets without making a throughly studies. The more baskets, the harder you hold the basket and care for the eggs inside. "Diversification is the protection against igrorance."

Berkshire's 40 Years Wisdom of Life 7: Creative Accounting

"We prefer better profits to better cosmetics.


Over the years, a number of very smart people have learned the hard way that a long string of impressive numbers multiplied by a single zero always equals zero. That is not an equation whose effects I would like to experience personally, and I would like even less to be responsible for imposing its penalties upon others." -- Warren Buffett, Letter To Shareholders, Berkshire Hathaway Inc., 2005.

Berkshire's 40 Years Wisdom of Life 6: Newton 4th Law of Motion

"Long ago, Sir Isaac Newton gave us three laws of motion, which were the work of genius. But Sir Isaac’s talents didn’t extend to investing: He lost a bundle in the South Sea Bubble, explaining later, “I can calculate the movement of the stars, but not the madness of men.” If he had not been traumatized by this loss, Sir Isaac might well have gone on to discover the Fourth Law of Motion: For investors as a whole, returns decrease as motion increases." -- Warren Buffett, Letter To Shareholders, Berkshire Hathaway Inc., 2005.

Note: Bank of England Museum, London is a place worth for visit if you wish to know more about the origin of South Sea Bubble.

Berkshire's 40 Years Wisdom of Life 5: CEO Pay

"Getting fired can produce a particularly bountiful payday for a CEO. Indeed, he can “earn” more in that single day, while cleaning out his desk, than an American worker earns in a lifetime of cleaning toilets. Forget the old maxim about nothing succeeding like success: Today, in the executive suite, the all too-prevalent rule is that nothing succeeds like failure." -- Warren Buffett, Letter To Shareholders, Berkshire Hathaway Inc., 2005

Loser's Game

“Investors have been so oversold on diversification that fear of having too many eggs in one basket has caused them to put far too little into companies they thoroughly know and far too much in others about which they know nothing at all. It never seems to occur to them that buying a company without having sufficient knowledge of it may be even more dangerous than having inadequate diversification.”
-- Philip Fisher in "Common Stocks and Uncommon Profits"

Berkshire's 40 Years Wisdom of Life 4

"The attitude of our managers vividly contrasts with that of the young man who married a tycoon’s only child, a decidedly homely and dull lass. Relieved, the father called in his new son-in-law after the wedding and began to discuss the future:
“Son, you’re the boy I always wanted and never had. Here’s a stock certificate for 50% of the company. You’re my equal partner from now on.”
“Thanks, dad.”
“Now, what would you like to run? How about sales?”
“I’m afraid I couldn’t sell water to a man crawling in the Sahara.”
“Well then, how about heading human relations?”
“I really don’t care for people.”
“No problem, we have lots of other spots in the business. What would you like to do?”
“Actually, nothing appeals to me. Why don’t you just buy me out?”

(“Whose bread I eat, his song I sing.”)" -- Warren Buffett, Letter to Shareholders, Berkshire Hathaway Inc., 2005.