Finding value as a Singapore investor through investing in portfolio of global ETFs
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This document discusses constructing a portfolio of exchange traded funds (ETFs) to provide ex ante returns for retail investors in Singapore. It identifies common investing mistakes made by retail investors in Singapore, such as lack of diversification and home bias. The document then evaluates various ETFs based on criteria like history, liquidity, diversification and performance to select a portfolio of 6 ETFs covering different asset classes and geographical regions. Back-testing shows the selected ETF portfolio achieved higher returns with lower risk than a benchmark Singapore index fund over the past 8 years. Factors like historical fund performance in recessions/non-recessions, predicted recession probability, and future trends are also considered to estimate the ex ante returns of the portfolio
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Finding value as a Singapore investor through investing in portfolio of global ETFs
- 1. EX ANTE RETURNS FROM A PORTFOLIO OF ETFs PREPARED BY: Alvin NEO LEE Xuan De LIM Jun Hao Jeffrey TANG Wayne KANG
- 2. Retail investors are prone to making these basic investing mistakes, cumulating in them putting all their eggs in the same basket. This increases the risk that they are exposed to. Introduction Singapore investor investing in Singapore equity, while holding on to Singapore based jobs and living in Singapore based property. Home Biasness Singapore retail investors tend not to diversify out of a few equity or bonds. This may be due to lack of knowledge or hassle involved. Lack of Diversification Due to home-biases, Singapore investors rarely trade in overseas where returns are on average higher, albeit with higher risks. Non-participation Exchange Traded Funds 1. High Diversification 2. Low Fees 3. High Variety 4. Easy Access
- 3. Ex Post SPDR STI ETF Returns -25.0000% -20.0000% -15.0000% -10.0000% -5.0000% 0.0000% 5.0000% 10.0000% 15.0000% 20.0000% 25.0000% 01/04/2005 01/06/2005 01/08/2005 01/10/2005 01/12/2005 01/02/2006 01/04/2006 01/06/2006 01/08/2006 01/10/2006 01/12/2006 01/02/2007 01/04/2007 01/06/2007 01/08/2007 01/10/2007 01/12/2007 01/02/2008 01/04/2008 01/06/2008 01/08/2008 01/10/2008 01/12/2008 01/02/2009 01/04/2009 01/06/2009 01/08/2009 01/10/2009 01/12/2009 01/02/2010 01/04/2010 01/06/2010 01/08/2010 01/10/2010 01/12/2010 01/02/2011 01/04/2011 01/06/2011 01/08/2011 01/10/2011 01/12/2011 01/02/2012 01/04/2012 01/06/2012 01/08/2012 01/10/2012 01/12/2012 01/02/2013 01/04/2013 01/06/2013 01/08/2013 01/10/2013 01/12/2013 01/02/2014 01/04/2014 01/06/2014 01/08/2014 01/10/2014 01/12/2014 01/02/2015 8 years average monthly return 0.568% 8 years annualized return 7.034%
- 4. Criterions of Selection Sufficient History Sufficient history provides more information for analysis of ETF. Liquidity A high liquidity ensures that the bid- ask spread of the ETF is low, which does not erode our total yield. Low Correlation To avoid home biasness, ETFs selected should be of low correlation with STI Index. Geographical Spread Greater geographical spread ensures that our portfolio is less affected by regional problems. Positive Sharpe Ratio Positive Sharpe ratio indicates positive excess returns for amount of risk taken Large Fund Size Large market capitalization reduces tracking error of ETF, thereby decreasing the transaction cost.
- 5. Methodology Universe of ETF Positive Sharpe Ratio High Liquidity Sufficient History Large Fund Size Low Correlation Pool of Portfolios to pick from
- 6. Asset Classes ETFs that trade primarily in stocks of companies. Further separated into large, med and small cap Equity ETFs that hold assets dealing with commodities related items. Yields are sensitive to market news. Commodities ETFs that hold on to underlying assets relating to the healthcare industry Healthcare ETFs which hold bonds from various companies and governments. Bonds The asset class of an ETF determine its underlying risk profile, which provides an indication of the possible level of yield the ETF is able to return.
- 7. iShares Core US Aggregate Bond (AGG) Components of Our Portfolio AGG consists mainly of US treasury securities and bonds of US large-cap companies providing stability to the portfolio iShares JPMorgan USD Emerging Markets Bond (EMB) EMB provides investors with exposure to US dollar-denominated government bonds issued by over 30 emerging market countries, holding 77.77% worth of sovereign debt. SPDR Select Healthcare Fund (XLV) XLV tracks an index of US based healthcare related equity. iShares China Large-Cap ETF (FXI) FXI tracks an index containing 50 of China’s largest cap firms, listed on the HK exchange. iShares MSCI Hong Kong ETF (EWH) EWH contains a mix of large and mid-size capped companies, hence moderate risk. Risk profile is balanced with lower risks large- capped companies Energy Select Sector SPDR (XLE) XLE consists of a basket of equity of large cap energy related companies dealing with oil, petroleum and natural gas, with a wide geographical spread.
- 8. Geographical Spread iShares MSCI Hong Kong ETF (EWH) Energy Select Sector SPDR (XLE) iShares China Large Cap ETF (FXI) iShares JP Morgan USD Emerging Markets Bond (EMB) SPDR Select Healthcare Fund (XLV) iShares Core US Aggregate Bond (AGG)
- 9. Energy Select Sector SPDR (XLE) Large Market Capitalization: US$13.84 billion Relatively high annualized ex post returns: 7.7416% Low Expense Ratio of 0.15% Beta of 0.557 Sharpe Ratio of 0.2233, indicating positive excess returns in relation to risk undertaken Low current oil price: $45.72 as of 23rd March 2015 Holdings in equity of companies dealing with oil, petroleum, gas & natural resources Reasons for selection
- 10. iShares China Large Cap ETF (FXI) Tracks MSCI China NR Index, invested in equity of China’s 25 largest and most liquid stocks dealing with array of services including financials, energy, telecommunications, technology, industrial and utilities. Large Market Capitalization: US$6.07 billion High annualized ex post returns: 8.6436% Moderate level expense ratio: 0.74% Beta of 0.2422, good hedge against local downturns due to weak correlation Sharpe Ratio of 0.2186, indicating positive excess returns in relation to risk undertaken Reasons for selection
- 11. iShares JP Morgan USD Emerging Markets Bond (EMB) Large Market Capitalization: US$4 billion High annualized ex post returns: 8.0007% Low Expense Ratio of 0.60% Beta of 0.884 Sharpe Ratio of 0.5399, indicating positive excess returns in relation to risk undertaken High diversification as no single country accounts for more than 7% of the total ETF Tracks an index composing of 30 U.S. denominated emerging market sovereign bonds. Reasons for selection
- 12. SPDR Select Healthcare Fund (XLV) Tracks an index composing of equity of companies dealing with pharmaceuticals, biotechnology, life sciences, equipment & supplies Large Market Capitalization: US$110 billion High annualized ex post returns: 13.0938% Low Expense Ratio of 0.15% Beta of 0.789 Sharpe Ratio of 0.6637, indicating high positive excess returns in relation to risk undertaken Provides the highest ex post returns due to a booming healthcare industry. Reasons for selection
- 13. iShares Core US Aggregate Bond (AGG) Tracks an index composing of investment grade US bonds, giving stability to our portfolio. Large Market Capitalization: US$23.587 billion Average annualized ex post returns: 5.1005 % Very Low Expense Ratio of 0.08% Beta of 0.436 Sharpe Ratio of 0.8466, indicating positive excess returns in relation to risk undertaken Only invests in investment grade bonds, with over 36% consisting of US treasury bonds Extremely low default risk. Acts as defensive cover within our portfolio Reasons for selection
- 14. iShares MSCI Hong Kong (EWH) Tracks a market cap weighted index of firms that are listed on the Hong Kong Exchange. Large Market Capitalization: US$35.87 billion Average annualized ex post returns: 9.8157 % Low Expense Ratio of 0.48% Beta of 0.436 Sharpe Ratio of 0.3252, indicating positive excess returns in relation to risk undertaken Provides a liquid opportunity to gain exposure to the Hong Kong market, a major Asian financial market. Heavy weightage in stable financial conglomerates. Reasons for selection
- 15. Comparison of Chosen ETF with SPDR STI ETF 0 1 SPDRSTIETF HealthCareSelectSectorSPDR®Fund EnergySelectSectorSPDR®Fund iSharesCoreU.S.AggregateBondETF iSharesChinaLarge-CapETF iSharesJ.P.MorganUSDEmerging MarketsBondETF iSharesMSCIHongKongETF Beta 0 1 SPDRSTIETF HealthCareSelectSectorSPDR®Fund EnergySelectSectorSPDR®Fund iSharesCoreU.S.AggregateBondETF iSharesChinaLarge-CapETF iSharesJ.P.MorganUSDEmerging MarketsBondETF iSharesMSCIHongKongETF Sharpe Ratio % SPDRSTIETF HealthCareSelectSectorSPDR®Fund EnergySelectSectorSPDR®Fund iSharesCoreU.S.AggregateBondETF iSharesChinaLarge-CapETF iSharesJ.P.MorganUSDEmerging MarketsBondETF iSharesMSCIHongKongETF Annualised Stdev
- 16. Ex Post Overall Returns for SPDR 0 0.5 1 1.5 2 2.5 01/2008 03/2008 05/2008 07/2008 09/2008 11/2008 01/2009 03/2009 05/2009 07/2009 09/2009 11/2009 01/2010 03/2010 05/2010 07/2010 09/2010 11/2010 01/2011 03/2011 05/2011 07/2011 09/2011 11/2011 01/2012 03/2012 05/2012 07/2012 09/2012 11/2012 01/2013 03/2013 05/2013 07/2013 09/2013 11/2013 01/2014 03/2014 05/2014 07/2014 09/2014 11/2014 SPDR STI ETF Health Care Select SPDR* Fund Energy Select Sector SPDR* Fund iShares Core U.S. Aggregate Bond ETF iShares China Large-Cap ETF iShares MSCI Hong Kong ETF iShares J.P. Morgan USD Emerging Markets Bond ETF Based on the historical data, we calculated the monthly ex post returns of each individual ETF, placing SGD $1 for ease of measuring
- 17. Ex Post Overall Returns for SPDR 0 0.2 0.4 0.6 0.8 1 1.2 1.4 1.6 1.8 01/2008 03/2008 05/2008 07/2008 09/2008 11/2008 01/2009 03/2009 05/2009 07/2009 09/2009 11/2009 01/2010 03/2010 05/2010 07/2010 09/2010 11/2010 01/2011 03/2011 05/2011 07/2011 09/2011 11/2011 01/2012 03/2012 05/2012 07/2012 09/2012 11/2012 01/2013 03/2013 05/2013 07/2013 09/2013 11/2013 01/2014 03/2014 05/2014 07/2014 09/2014 11/2014 SPDR STI ETF Subsequently, we computed the overall portfolio return with the assumption of equal weightage of our 6 chosen ETFs. Overall Portfolio Results: SPDR STI ETF Our Portfolio Annualized Return 7.0340% 7.530% Annualized StDev 20.1734% 16.367% Beta 1 0.52991 Sharpe Ratio (Risk-free = 2.3%) 0.2347 0.31953
- 18. Ex Ante Return We incorporated a multitude of factors in calculating the ex ante expected returns for our portfolio: 1. 2. 3. Ex post returns for each ETF are categorized according to two states of nature, recession and non-recession, determined based on Singapore’s GDP % growth figures. This gives us an accurate historical measure of how the ETF performed during each event. We computed the future probability of recession based on the theory of yield curve inversion. This provides us with a mathematical basis to compute our ex ante returns. Sometimes, the past may not accurately represent what may occur in the future. Hence, we have adjusted the predicted returns of each ETF and its weightage within our portfolio based on 5 key future trends that we have identified. Ex Post Returns Recession Probability Trend Analysis
- 19. Ex Post Returns on our Portfolio1. The shaded portion refers to period where recession occurred in Singapore. Hence, we took the average return of our chosen ETFs from that period as a base to work with for computing yields during recession period 0 0.5 1 1.5 2 2.5 01/2008 03/2008 05/2008 07/2008 09/2008 11/2008 01/2009 03/2009 05/2009 07/2009 09/2009 11/2009 01/2010 03/2010 05/2010 07/2010 09/2010 11/2010 01/2011 03/2011 05/2011 07/2011 09/2011 11/2011 01/2012 03/2012 05/2012 07/2012 09/2012 11/2012 01/2013 03/2013 05/2013 07/2013 09/2013 11/2013 01/2014 03/2014 05/2014 07/2014 09/2014 11/2014
- 20. Yield Curve Inversion in predicting recessions Yield curve inversion is widely regarded as an accurate predictor of recessions. The occurrence of recession will heavily impact most of our ETFs. Hence, it is important for us to factor in the likelihood of recession in our Ex Ante returns computation. 2.
- 21. Recession Probability We based our computation on the research of Wheelock and Wohar, 2009. Using the formula below, we plugged in the long term and short term yield of Singapore Treasury bonds to forecast the recession probability. 2. Based on our model, the recession probabilty for April 2015 stands at 8.39% Probability of Recession Future Forecast Due to the length of analysis (5 years), we project the probabilty of recession to be 15% for our calculation of ex ante returns
- 22. Trends Interest Rate Hike Emerging Market Growth Currency Movements Demographic Shifts Oil Price Outlook When interest rates are increased, borrowings decreases, leading to possible economic slowdown Emergence of BRIC countries presents opportunities for higher yield investments Currency movements will determine the attractiveness of the home country Demographic shifts affect the profitability of underlying assets of various portfolios, potentially affecting their Oil prices have a macro effect on various economic indicators and yield of energy intensive sector ETFs 3.
- 23. Based on the trends identified, we sought to rebalance our portfolio to effectively capture future growth prospects Ex Ante Reformulation of Our Portfolio Health Care Select Sector SPDR® Fund 35% Energy Select Sector SPDR® Fund 18% iShares Core U.S. Aggregate Bond ETF 8% iShares China Large- Cap ETF 18% iShares J.P. Morgan USD Emerging Markets Bond ETF 11% iShares MSCI Hong Kong ETF 10% Overweight Health Care Select ETF due to optimistic view on earnings of healthcare sector which have most businesses found in aging first-world countries Overweight iShares China Large-Cap ETF due to favourable future outlook relating to demographics, currencies, strengthening domestic market Overweight Energy Select Sector ETF because current suppressed prices of crude oil will not remain so in the long run Rationale
- 24. Component Breakdown of Ex Ante Expected Returns Below is the detailed breakdown of our computation on ex ante expected returns of our portfolio Health Care Select Sector SPDR® Fund Energy Select Sector SPDR® Fund iShares Core U.S. Aggregate Bond ETF iShares China Large-Cap ETF iShares J.P. Morgan USD Emerging Markets Bond ETF iShares MSCI Hong Kong ETF Portfolio Weightage 0.350 0.180 0.080 0.180 0.110 0.100 1.000 Recession Returns -6.9008% -6.6336% 0.2645% -5.0437% -0.8094% -3.7169% -22.8399% Non - Recession Returns 6.5358% 2.8918% 0.4287% 2.7169% 1.1854% 1.8687% 15.6274% Expected Weighted Returns 4.5204% 1.4630% 0.4041% 1.5528% 0.8862% 1.0309% 9.8573%
- 25. Computation of Ex Ante Expected Returns We used the above mentioned three portions to compute our ex ante expected returns for our portfolio, surmised in our table below Rs Ps * Rs State Probability STI ETF Portfolio STI ETF Portfolio Recession 15% -45.7624% -22.8399% -6.8644% -3.4260% No Recession 85% 17.5881% 15.6274% 14.9499% 13.2833% Total 8.0855% 9.8573%
- 26. Key Takeaway By holding onto a portfolio of diversified ETFs, Singapore retail investors can yield higher returns while undertaking lower risks, as compared to solely investing in the local market Annualized Returns Annualized Stdev Sharpe Ratio (Risk Free rate = 2.3%) Weighted Portfolio 9.8573% 13.7356% 0.582309848 STI ETF-only Portfolio 8.0855% 22.6206% 0.255762976
- 27. Limitations As with any projections, there will be limitations. Hence, we have included a sensitivity analysis: The magnitude of the yield curve inversion in SG is also not as obvious as that in the US, which may skew our calculations of recession probability. Slow Yield Curve Spread Predictions not reality Our predictions will only hold true if our estimates and macroeconomic trends hold true. High price The total price of 1 unit of our portfolio is $ 438.56 at 25/03/15 spot price. Our analysis assumes that our retail investor can afford this price.
- 28. ✉ Questions?