Monday, November 29, 2010

Answers for Thursdee, Part 1: First Metro Save and Learn Equity Fund


First Metro Save and Learn Equity Fund, Inc.(FMSLEQT:PM, red) outperforming BDO's Equity UITF (EPCIBEQ:PM, green) and the benchmark PSEi (PCOMP:IND, orange) in the last 12 months

Dear Investor Juan,

First and foremost, let me just say how very informative your blog is to those of us who can't understand investment language.

My family has accumulated modest savings this year which we initially intended to invest in a time deposit account and a balanced fund. I've been doing my research, but sadly, my math-averse brain can only take so much information. It's so difficult for me to understand the banking world's jargon. Thankfully, I came across your blog before my math-averse brain crashed. So now, we've decided to invest 50,000 pesos in an equity fund, most probably in BDO. I still have several questions to ask though.

[questions printed below]

I do hope you'd reply to my queries to save my overworked brain from further damage. Thanks again and may you be blessed for helping us who can't afford to pay financial advisors!


Dear Thursdee,

Thanks for the compliment. I live to serve. :)

Now, on to your questions.

1. Before reading your blog, I was actually "studying" the NAVPS performance table on the Investment Company Association of the Philippines (ICAP) website. I noticed that First Metro Asset Management, Inc.'s (FAMI) First Metro Save and Learn Equity Fund has the highest percentage returns among all the other funds. And also, the funds managed by banks are not listed there. Is it advisable to invest directly with FAMI than through a bank? How do I go about doing that?

FAMI's equity fund has indeed been significantly outperforming other mutual funds in its class, and actually even UITFs and the PSEi, in the past five years.

This kind of sustained "strong" performance is rare in the fund management industry, where success is attributed to luck, as several noteworthy studies in the US show. And while I would tend to agree to the idea that past performance matters little in choosing investment funds, I may have to make an exception with FAMI's equity fund: significantly outperforming the benchmark and other funds in the same class continuously for five years does point more towards skill than luck.

And don't think FAMI does not know that.

In discussing UITFs in previous posts, we often talked about management, trust, or custodian fees that could serve as one basis in choosing a fund. While mutual funds and UITFs are basically the same, one important difference is that the former charges sales load fees on top of the basic management fee, making mutual funds more expensive than UITFs. 

Take FAMI's equity fund as an example. It charges a front-end sales load of 0.5 to 2% of the invested amount, on top of a 1.75% per year management fee. Of course that extra fee may be well worth it if the fund can give you 50% higher returns, but as I always say, nothing in making investments is certain.

The funds listed on the ICAP website are all mutual funds, and you won't find any UITFs there. UITFs are offered by banks, and mutual funds by other financial institutions like insurance companies and bank affiliates, although some funds like the ALFM funds of Ayala Life can also be purchased from BPI. Also, while UITFs may only be purchased from the bank of your choice, you can buy mutual funds also through authorized agents or sales representatives.

If you're really interested in investing in FAMI's First Metro Save and Learn Equity Fund, you would have to accomplish some forms and follow these instructions from the company's website.

By the way, if you want to compare the performance of different funds with graphs (and without the math), just like I do here, you can go to and use the site's interactive chart. You can find the "Bloomberg ticker" of the fund using the search bar at the upper right corner of the page.

Part 2 for your other two questions in my next post.

Thursday, November 25, 2010

Capital Budgeting Part 2: The Net Present Value Rule


In Part 1, we talked about a situation where you, as the owner of Cheeky Chicken, are thinking of buying a new chicken deep fryer worth 4 million pesos and is expected to bring in additional profits of 1 million pesos per year; "additional" means if you already earn 2 million pesos with your existing set up, you expect to earn a total of 3 million pesos per year with the new machine. In making capital budgeting decisions, you should not focus on your total earnings (3 million), but rather on the additional or incremental cash flows you expect the investment to generate.

To better visualize the situation, let's summarize the cash flows into a table. The negative 4,000,000 cash flow just means that it is a cash outflow and Year 0 means today or now.

As we explained briefly in Part 1, we can't just add the future cash inflows and compare the sum to the required investment because of time value of money: we have to convert all the cash flows to a common time reference, given the rate of return of a comparable alternative investment, before we can compare the costs of the investment (cash outflows) to its benefits (cash inflows). And the easiest way to do this would be to determine how each cash flow is worth today by getting its present value.

For example, if you can earn 5% per year on an alternative investment, compounded annually, how much would you need now to have 1 million pesos by the end of the year? If you answer 952,381 pesos, you're right; you get that by dividing the future value, which is 1,000,000, by 1 plus the rate of return, or 1.05. So, we say that 952,381 is the present value of the 1,000,000 cash flow in Year 1; alternatively, we can say that we need to invest 952,381 today at 5% per year to have 1,000,000 by the end of the year.

How about the present value of 1,000,000 in Year 2? The 1,000,ooo in Year 3? As many of you might have already figured out, we can get the present value (PV) of any future amount (FV) in period t, given a rate of return r, with the following equation:

Which gives us present values of 907,029 and 863,838 to the cash flows in Years 2 and 3, respectively.

If you're allergic to this kind of math (who isn't, right?), then there's always Excel.

Notice that farther away in the future a cash flow is, the lower its present value; this is just consistent with our definition of time value of money, that earlier cash flows are more valuable than later cash flows.

Finally, to be able to decide whether it's a good idea to buy that new fryer or not, just add the present values of all the cash flows and get the net present value or NPV of the investment.

A positive NPV means the benefits of an investment outweigh the costs, considering time value of money, so you should accept or go through with the investment; a negative NPV means you will be better off investing in the alternative investment instead. In our Cheeky Chicken example, since the deep-fryer has an NPV of positive 329,477 pesos, then it makes good economic sense to pursue the venture; buying the machine would provide an additional value of 329,477 pesos, on top of 5% per year which is some sort of benchmark return.

As fundamentally sound as the NPV rule is, it's not fool proof. Basically, it depends on two very important inputs:
  1. The future incremental cash flows the investment or project is expected to generate.
  2. The rate of return of a comparable, alternative investment.
Therefore, the reliability of your NPV calculation is just as good as your estimates of these two inputs, and as they say, garbage in, garbage out. In practice, these two inputs are not easy to estimate accurately; still, you should be able to come up with reasonable assumptions that will make your computations more believable.

Do you think this is too much trouble for a piece of kitchen equipment? Actually, while most books recommend the use of NPV in capital budgeting, most businesses use other, more informal alternative criteria. And that's what we will talk about in Part 3.

Monday, November 22, 2010

Ten Questions For Mark Cuban

We all know him as the hot-headed and very hands-on owner of the Dallas Mavericks. What most of us don't know is that Mark Cuban is a self-made billionaire, being one of the lucky few who were able to ride the wave and luckier still for being able to cash out just before the bubble burst. Here is the Forbes interview that will teach us a few things about how to build and keep a fortune.

1. What personality trait was the key to your success?

I worked hard and smarter than most people in the businesses I have been in.

2. What financial advice do you have for someone who is newly rich?

Cash is king.

3. How do you choose a money manager or investment advisor?

Someone who I can trust, has an idea every now and then, but most importantly can efficiently research my ideas and make the investments I ask them to make.

4. Talk about the most offbeat advice you followed.
I create offbeat advice; I don't follow it. I rarely take third-party advice on my investments.

5. What do you think are the biggest obstacles to job creation in America?

Complexity. You can't just start a company. You can't just take an idea and run with it, like you used to be able to. You have to have lawyers and accountants to make sure you have lived up to all the local, regional, state and national "administrivia" that is required of you. And once you get started you have to keep up with the administrivia. All of which is a huge inhibitor to business formation and a huge capital drain for any entrepreneur who is starting with sweat equity. The first cities to create friction-free enterprise zones will get a lot of entrepreneurial traction.

To help fix the economy, I would require any public company laying off more than 1,000 employees at a time, or in aggregate for a single year, to put the details up for a shareholder vote.

I'm guessing that most shareholders realize that losing a penny a share or two in earnings is less expensive than the cost to them in taxes to cover the cost of more people joining the ranks of the unemployed.

6. Who is your hero, and why?

My dad. He made me believe in myself.

7. What are the unforeseen downsides to success? 

You become a target for extortionists who are looking for skins on the wall or easy money. I spend far too much time and money crushing all the nuisance suits that are filed. If you try to make me a skin on your wall or an easy payout, I will do everything in my power to bring justice to the situation. No matter how long it takes or how much it costs.

8. What book should every entrepreneur read?

The Fountainhead.

9. You have $100,000--where do you put it?

First I pay off all my credit card debt and evaluate paying off any other debt I have. What I have left I put in the bank.

Then I try to create as much transactional value as possible from that cash. I look at my annual budgets for everything and anything, and I look to see where I can save the most money on those items. Saving 30% to 50% buying in bulk--replenishable items from toothpaste to soup, or whatever I use a lot of--is the best guaranteed return on investment you can get anywhere. Then whatever I have left I keep in the bank and let it earn nothing. Why? Because then its available for when I get a good opportunity.

Every five years or so there is a bubble bursting or amazing deals available because of a change in the economy. Anyone who just kept their cash in the bank rather than in stocks over the past five to 10 years could be buying the home of their dreams for half price in most of the country. They earned good money in half the past 10 years on the cash, and even though they aren't making much now, they have the transactional value available to them. Plus they have cash to invest if the market craters and, most importantly, they sleep great at night. Cash is king--and works far better than Ambien when you want a good night's sleep every night.

10. Name one experience every entrepreneur-to-be must have.

Coming home and having the lights turned off because you couldn't afford to pay the bills. It's incredibly motivating and humbling.

Thursday, November 18, 2010

Jollibee - Mang Inasal Update


If you take a brief look at our front page, you'll see that our Mang Inasal post about a month ago is now the most viewed post on this blog. So, since we all clearly still haven't had enough of this "match made in heaven," here's the latest on the Jollibee-Mang Inasal acquisition.

Don't get your hopes up, it's nothing much, really: it's just that this news article press release confirms that money has already changed hands and that the deal is now official. Mr. Edgar "Injap" Sia is now 1.55 billion pesos richer, and on November 22 he can add 1.15 billion pesos more to his stash; the remaining 300 million or 10 percent of the purchase price will be withheld and paid over the next three years as "assurance for indemnification against the seller’s representations and warranties," whatever that fancy phrase means.

All this is really not very interesting, as we all had been pretty much certain that the deal will push through. So to add a little spice to this post, let's take a closer look at how Jollibee (JFC) justifies the purchase to the investing public, how the deal "is estimated to add at least 5 percent to JFC’s worldwide sales, 5 percent to total revenues and 7 percent to net operating income attributable to parent equity holders." (By the way, if you check out that article a month ago, you'll notice that JFC has already made this exact same statement then, which may mean countless things that I'll leave up to you to think about.)

A 7% increase in operating income (earnings before interest and taxes) roughly translates to an increase in net profit and dividends of 5% (7% x (1 - 30%) = 4.9%, where 30% is the corporate tax rate) from present levels. Just before the announcement, on October 15, JFC had a total market capitalization (just a fancy term for market value) of around 90 billion pesos; the expected 5% increase in profit and dividends should then result in an increase in value of 5% of 90 billion or 4.5 billion pesos, 50% higher than the acquisition price of 3 billion pesos. So, on paper, if we believe JFC's pronouncement that its purchase of the majority stake at Mang Inasal will result in a 7% increase in operating profit, then the deal makes perfect (and handsomely profitable) economic sense for Jollibee.

But what do investors think? Well, since that extraordinary jump in stock price from 89.80 to 97 just after the announcement was made, there had been no sign that investors believed the deal would provide 1.5 billion pesos (4.5 billion - 3 billion) of additional value to the firm; in fact, the stock is now even a few points lower than the pre-announcement price, closing at 87 pesos in today's trading. A sign that investors don't like the deal? Or don't like the deal enough to wait for the promised gains to materialize?

But maybe you'd want look at it this way, instead. If you think it makes sense that Mang Inasal would increase Jollibee's total sales by 5% or operating profit by 7%, just as JFC announced, then Jollibee at 87 pesos is a bargain, and if you buy now you stand to gain around 5% when the stock reaches its "true" price of 91.50 per share.

What do you think? Just look at all these interesting possibilities. Isn't investing fun? :)

Monday, November 15, 2010

Capital Budgeting Part 1: Making Long-term Investment Decisions for Your Business


Capital budgeting is the decision-making process with respect to investments in long-term assets--machinery and equipment, vehicles, and real property--with the purpose of enhancing the value of a business. Some examples of capital budgeting decisions include:
  • The development and introduction of a new product to the market
  • Replacing an old piece of equipment with a newer model
  • Expanding production capacity
These decisions are "long term" since they cannot be "unmade" without incurring significant losses. And since these investments usually entail a huge amount of capital, it pays to know the best way of making such decisions.

The central idea in capital budgeting is to weigh the costs associated with the purchase against the expected benefits. Apart from the actual cost of the asset in question, like, say, an expensive deep fryer for your fried chicken business, other "costs" of the investment include transportation and installation (if they're not yet included in the sticker price of the machine) and investments in materials or inventory needed to make use of the asset (an increase in your inventory of dressed chicken). The benefits of the investment come from the additional cash flows you expect the asset to deliver in the future (maybe you're considering buying the new fryer because it can cook more chicken faster, which you estimate can boost your sales and cash flows significantly). In performing cost-benefit analysis, if the benefits of the asset in question outweigh the costs, then buying it would make economic sense; if it’s the other way around, if costs outweigh the benefits, then you would be better off spending your money on other value-boosting investments.

Unfortunately, of you really want to make the best decision for your business, you will have to complicate things a bit. In a previous post, we talked about time value of money: the idea that receiving money earlier is better, and vice versa. This notion complicates the cost benefit approach we discussed above; since cash received earlier is more valuable that that received at a later date, we can't just add all the future monetary benefits of an investment because they usually occur at different times. Which means, if you expect your new fryer to provide additional cash flows of 1 million pesos per year in the next five years, the benefit of the investment is not 1 million x 5 years = 5 million pesos because, with time value of money, the first million you'll receive is more valuable than the one you'll receive in five years. 

To better understand this concept, let's take a look at a specific example. Say, you're the owner of Cheeky Chicken, and you operate a small chain of fried chicken restaurants in the country. You're thinking of adding new capacity to your restaurants, and you're interested in buying a new deep fryer--the latest model--for 4 million pesos. Based on you rough estimates, the new fryer can bring in additional cash flows of 1 million pesos a year in the next five years, after which the machine will be fully depreciated and useless.

Without time value of money, the decision to buy the machine or not seems very uncomplicated: comparing the machine cost of 4 million pesos to the total benefit worth 5 million pesos clearly shouts buy. But what if you know you that can also invest your 4 million pesos in a fund that pays 5% per year? Now the decision to buy the machine or not is not so simple anymore, since now you have an alternative use for your capital that may provide better benefits. So how can we use this new information to make the right decision?

Those of you who still remember a bit of your high school math may be thinking along these lines: if we invest 4 million pesos at 5% per year, interest compounded annually (meaning interest also earns interest every year), that will give us 4 x (1.05)^5 or around 5.1 million pesos after five years, which is higher than the 5 million peso total benefit provided by the machine, which makes not buying the machine the right decision, right?

Well, almost, but not quite. While we have considered time value of money to evaluate the next best use for our capital (investing in the fund), we failed to use it with the benefits of the machine. Remember: with time value of money, earlier cash flows are worth more than those that come later, so the machine does not really provide a net benefit of 5 million pesos. So how exactly can we do this the right way? Well, you'll have to wait for Part 2 to find out. ;) 

Saturday, November 13, 2010

4 Questions About REITs Answered


In a previous post, we caught a brief glimpse of Real Estate Investment Trusts or REITs and how it gives "small" investors a more affordable way of investing in real estate. Recently, the Philippine Stock Exchange released a primer about this new investment vehicle that's about to enter our market. Here are some of the more important things you need to know about REITs.

1. What exactly is it?

A Real Estate Investment Trust (REIT, pronounced as “reet”)  is a stock corporation created for the purpose of owning and managing income-generating real estate such as office buildings, residential condominiums, shopping centers, hotels, warehouses, hospitals, airports, and tollways. The Philippine REIT, under Republic Act No. 9856, otherwise known as the REIT Act of 2009, requires REITs to list its shares of stock on the Philippine Stock Exchange or PSE. The REIT distributes 90% of its distributable income to investors in the form of regular dividends and receives special tax considerations as an incentive.

REITs allow investors--especially small or retail investors--to participate in the ownership of one or more income-generating real estate. For property developers, REITs provide to ready capital which may be immediately used to finance new projects and investments.

2. What are the allowed activities and investments of REITs?

REITs are allowed to make investments in the following:
  • Real estate;
  • Real estate-related assets;
  • Managed funds, debt, securities, and listed share issued by local or foreign non-property corporations;
  • Government securities (issued in the Philippines and others);
  • Cash and its equivalent; and
  • Similar investments (see REIT Act IRR).

3. How do investors earn from owning REIT shares?

Owning REIT shares is like owning a hybrid fixed income and equity security. Since REITs have access only to a limited number and specific types of investments, earnings distribution in the form of dividends should be more reliable and stable than dividends paid by stock companies. Also, since REIT shares are freely traded in the market, investors can also benefit from capital appreciation when there is high demand for the shares.

4. What are the other advantages of investing in REITs?

Through REITs, investments in real estate become more affordable to small or retail investors. And since there is (presumably) a ready market for REIT shares, investments in REITs are more liquid than direct investments in real property.

Finally, because REITs offer features that are distinct from traditional investments like bonds and stocks, they can enhance an investor's portfolio through more effective diversification.

Monday, November 8, 2010

4 Simple Ways of being More Confident of Your Future Finances

A recent study in the United States reveals that specific financial decisions and behavior can help uplift an individual's or family's feelings of economic security, especially during financial crises and recessions. Based on the results of a survey of more than 9,000 respondents over a two-year period, behavior that revolve around financial planning and a more disciplined approach to debt and savings was found to foster a feeling of economic security and optimism about the future.

1. Save more, regularly. Among the survey respondents, 44% of those who saved the most from month to month described themselves as “very” or “extremely” optimistic about their future finances. And 40% of those having the highest savings balances expressed similar optimism. But even among those with the lowest savings balance, 57% of those who consistently put money into savings also expressed optimism about their financial future. These findings show that financial optimism does not depend on how much one has already accumulated in savings--rather, it’s the practice of saving, itself, that creates an emotional lift.

2. Pay off your short-term debt. Carrying too much credit card debt and personal loan balances can greatly reduce an individual's or family's optimism about their future finances. In the survey, only about 35% of survey participants said they feel “very” or “extremely” financially secure from month to month, and only about 34% expressed optimism for their financial future. But among those with high short-term debt, expressions of financial optimism went down to 20%. What’s more, those most concerned about their debt are more likely to feel financially “stretched” from month to month--and are the least likely to make saving and investing a priority.

3. Increase your savings-to-debt ratio. One of the most important results of the study is that an individual or family can have some debt and still feel financially secure--as long as they’re disciplined in their approach to savings and diligent in their payment of debt. The savings-to-debt ratio thus appears to be a very important contributor to feelings of financial optimism, since as one’s savings-to-debt ratio increases, feelings of financial security increase, and feelings of being financially “stretched” decrease.

4. Come up with--and stick to--a financial plan. The survey shows that individuals and families having a financial plan are more likely to have a high savings-to-debt ratio than those without a plan. And this is consistent across all incomes, indicating that a family earning $50,000 per year can achieve the same level of financial optimism and confidence as a family earning $100,000 per year or more--if it is managing money according to a sound financial plan. 45% of survey respondents with a financial plan reported feeling “very” or “extremely” secure financially, compared to 31% of respondents without a plan. Finally, persons having a financial plan expressed significantly more confidence in dealing with financial matters than those without a plan, and they reported greater confidence in their ability to retire comfortably.

The message is simple: save more, pay off your debt, and take control of your finances by living by a financial plan, even a simple one. Visiting Investor Juan regularly is a good first step, and we'll always be here to support you the moment you take your next.

Friday, November 5, 2010

5 Unbelievable Benefits of Taking a Nap

All of us have experienced first-hand the irresistible wile of the afternoon nap. When I was still teaching at the Ateneo, I was often assigned after-lunch classes; I'm sure you can imagine how challenging it had been for me to make my students focus on our lesson as they faced an often losing fight against midday drowsiness. But according to several studies, it may be best if we all just give in to the temptation and just sleep when we feel like it. Here are some of the most important reasons why:

1. Napping relieves you of stress. That's the most direct and obvious benefit. Taking a short nap when you feel tired or stressful is the best way to recharge your body and mind.

2. Your mind gets prepped to learn more things. The part of the brain that receives and stores new information may be likened to a 90's hard drive that you need to defragment from time to time. Around eight hours after waking up in the morning, the brain gets cluttered with all kinds of stuff; taking a nap at this time is just like defragmenting your hard drive, removing the clutter and providing room for new information.

3. Your memory gets refreshed and you become smarter. Many of us believe that the best way to prepare for an exam is to take in copious amounts of caffeine to fend off sleep and hit the books. But in an experiment performed at University of California San Diego involving two groups, one given a caffeine pill and the other asked to take a nap, the sleep group performed significantly better in memory-related tasks than the other group. This just means the trip to Starbucks for a group study all-nighter with your friends may be the more expensive and ineffective alternative to staying home and sleeping early.

4. You get to be more alert and productive. Taking a short afternoon nap, especially after a poor night of sleep, will make you feel more alert afterwards. Soon after, you'll find yourself in a better mood and better suited to perform different kinds of tasks, both mental and physical.

5. Naps make you more healthy. Two studies housed at the Sleep and Psychological Disorder Laboratory at University of California Berkeley show that getting a good amount of sleep is tied to a better immune system and metabolic control. In another study involving 23,681 individuals living in Greece, researchers found that those who took naps several times a week had a significantly lower risk of heart disease.

Monday, November 1, 2010

5 Things You Need to Know About Exchange Traded Funds


On Friday, I decided to buy Hong Kong securities for the first time. Most of you know that I'm an ardent opponent of stock picking, so to put my money where my mouth is, I decided to go by the way of diversified investment funds. Like all other commercial banks in Hong Kong, Hang Seng Bank, where I decided to open and maintain an account, offers a more exhaustive and thorough list of securities and investment services than the banks in the Philippines. For my particular investment preference, aside from open-ended investment funds (which are basically the same as the mutual funds and UITFs we have back home), Hong Kong banks and other financial institutions also offer exchange traded funds or ETFs, which is something we don't have in the Philippines.

On Friday, I bought 100 shares of Hang Seng Bank's Hang Seng Index ETF (stock code 2833) at the prevailing market price of 233.20 HKD per share. At the end of today's trading, the stock closed at 240.00 HKD per share, netting me gross paper gains of 680 HKD over the weekend, or 3,772.67 pesos. Not bad at all, but of course that's mostly due to luck than anything else.

So what are these ETFs, and why are they so popular in a lot of markets around the world? And how are they different from the more familiar mutual funds and UITFs that we have in the Philippines?

1. ETFs are investment funds that can be traded in stock exchanges, unlike mutual funds and UITFs that may only be sold by and redeemed through financial institutions like banks. Also, ETFs are closed-ended, with a fixed number of outstanding shares available, unlike open-ended mutual funds and UITFs; this is what makes trading ETFs in stock markets possible.

2. ETFs are also invested in underlying securities like stocks, bonds, and other instruments, like other investment funds. The ETF I purchased tracks the Hang Seng Index of the Hong Kong stock exchange, and is thus invested in the component stocks of that index.

3. ETF share prices are determined by the market. The share price of ETFs are driven by supply and demand forces, unlike open-ended funds whose net asset values (NAV) are computed at the end of each trading day. Therefore, while a lot of ETFs are designed to closely follow the movement of certain indexes, ETF returns can still deviate significantly from the performance of the underlying assets or index.

4. ETFs are much cheaper than other investment funds. While a lot of open-ended investment funds in Hong Kong charge around 3% per year in fees, ETFs are just covered by the usual trading charges, which amount to just around 0.6% per transaction. Therefore, if you are a firm believer of passive over active investment, then ETFs are the way to go since you won't have to pay for high management fees.

5. ETFs pay dividends to shareholders, unlike mutual funds and UITFs that reinvest all gains back into the fund. For example, the HSI ETF I bought has a historical dividend yield (dividends divided by the share price) of 2% per year. This yield makes up a portion of the total returns earned by investors, on top of capital gains when the share price appreciates.

It's unfortunate that ETFs are not available to investors in the Philippines; the funny/frustrating thing is that an ETF based on Philippine stocks has already been made available in international exchanges for international investors, but it's not available to us poor Investor Juans. Still, there are rumors that ETFs will soon be introduced in the Philippines. Would you be interested in buying some when they do become available?

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