For those of you who missed it, the past week saw us addressing a great query from a 25 year old reader who wanted to know how to invest his way to a multi-millionaire (it was a great query btw, do check it out here).
And just a couple days later, I received this fantastic comment from an older reader, with a slightly different problem on dividend portfolios. I’ve extracted it in its full glory below:
Hi FH, very sensible chap you are. Since it is the end of the year, perhaps I can offer another scenario that is the exact opposite of the 25 year old just starting out in career one for you to consider and help your readers with.
I like your all weather portfolio and the Singapore version as well but if one is close to retirement and has a substantial portfolio of say $10M, then the Singapore version runs into challenges That’s because for the bond part of the portfolio, one quickly runs into upper limits of how much one can put into CPF OA and SA as well as SSB. What is left to invest in are SGS which has very low yield vs US treasuries and US treasuries which are subject to 30% tax withholding on interest, reducing return substantially.
So this portfolio will not perform as well as Ray Dalio’s version which unfortunately works only for US residents not subject to the 30% interest tax withholding and who are not exposed to USD:SGD currency risk. Since the bond parts of the portfolio account collectively for 55% of overall portfolio, it is important to get them right.
The closest substitute I can find is to invest in Ireland listed corporate bond ETF instead but not sure it is the best alternative. The other challenge faced with this overall portfolio is that yield from dividends and interest generated is not very high and this makes it hard to sustain retirement without drawing from capital.
Any suggestions? Can you pls make a suggestion for All weather portfolio for Singaporeans to retire on with yield from dividends and interest in 3-4% range assuming a $10M asset size for investment? Thanks a lot and much appreciated!
Okay that’s a lot to take in.
Basics: What is the thinking behind the All-Weather Portfolio?
Now the All-Weather Portfolio (check out the original article here) is one of the most popular portfolios on Financial Horse. I get a ton of readers of all ages writing in with queries on it. I guess there’s just something about an investment portfolio that does well in all economic situations that really appeals to investors.
But there are a couple of key points that I wanted to clarify regarding the All-Weather Portfolio. Let’s trace back to the original purpose of the All-Weather Portfolio.
Ray Dalio created this in response to a question posed by Tony Robbins on what he would create as an All-Weather Portfolio for the average US investor, that would do well in all economic regimes. And his response was the below:
And this is important because:
What does well all the time, doesn’t do particularly well any time
It’s important to point out that the All-Weather Portfolio is designed to do well in all economic situations. This also means that it’s not going to perform well in any particular economic situation. This is important to remember when you find yourself underperforming the S&P500. This is the portfolio working as intended.
US Investors have access to US Treasuries
The All Weather Portfolio allocates about 55% to bonds, split between Long Term US Bonds and Intermediate US Bonds. This works fine for US investors because you just buy US Treasuries (directly or via bond ETFs) and be done with it. As the reader pointed out though, this doesn’t work so well for Singapore investors because we’re paying 30% withholding tax on all bond distributions in the US.
Now there are people who argue that this 30% withholding tax doesn’t matter because you still enjoy the capital gains, but I really, really disagree with this. I think that when you’re buying long term US Treasuries that yield about 2.3% for the 30 year now, and you’re losing about 0.6% plus returns to withholding tax, that really impacts future returns.
Sure, a big chunk of returns from bonds, historically, came from capital gains. But going forward, I just don’t think that’s going to be the case anymore.
It’s simple math right. US Treasuries went from 10% to 2% over the past 30 years, triggering a 30 year bond bull market.
To achieve the same kind of capital gains over the next 30 years, means the US Treasury goes well into the negative territory (negative 5% anyone?).
Given what a disaster negative interest rates have been for Europe and Japan, I’m fairly certain the US is not going to replicate it. Instead, the next big move from the US in the next recession is likely to be inflation.
Think about it this way. Imagine you’re the US Government and you owe the bank (holders of US Treasuries) $10 trillion dollars. How do you solve that problem?
(1) Firstly you lower the interest rates, so that the interest you’re paying on that $10 trillion goes even lower, and you just keep rolling the debt over. That’s already been done which is why interest rates are so low.
(2) The second method, is to create inflation. Let’s say your GDP is $15 trillion, so the debt as a percentage of your GDP is 66%. If you create inflation (price of everything goes up but total amount of goods/services stays the same) and your GDP rises to $20 trillion, then congratulations your debt at $10 trillion is now 50% of your GDP. It’s the same thing that has been done all throughout history, ever since the Roman Empire and beyond, and I think it may play out in some form in the coming years. If so, this may spark global inflation, and wreak havoc on global exchange rates.
What does this mean for Singapore Investors?
What this means for Singapore Investors, is one of two things:
US Bonds are not appropriate because of withholding tax – 30% withholding tax is really painful, enough said.
Medium term returns may be limited due to inflationary pressures and depreciation in the USD – So the US Treasuries you hold may generate good nominal returns, but once you factor in inflation and exchange rates, the real returns may be poor.
Long story short, US Treasuries are not ideal for Singapore investors in the All-Weather Portfolio. What is the appropriate replacement?
Replacement for US Treasuries?
To answer it simply, there is no replacement for US Treasuries. This is important to understand.
US Treasuries are a very unique asset class. They are sovereign debt guaranteed by the US government, in a world where the USD functions as the global reserve currency, the Federal Reserve dictates global monetary policy, and where US Treasuries are the single most deep and liquid sovereign debt market in the entire globe.
There’s just no replacement to it.
Sure if you go back 100 years you could make a good argument that Gilts (UK Government Debt) are better than US Treasuries. Heck you could even make the argument that in 50 years time RMB sovereign debt issued by the China Government are superior to US Treasuries. But the year is 2020, and as at right now, there really is no sovereign debt on the planet that has similar qualities to US Treasuries. People have been trying to replace it for a while now, to no success.
If there is a global crisis tomorrow, investors are still going to flood into US Treasuries, end of story.
Once we understand that there’s no perfect replacement to US Treasuries, then our life becomes a lot easier. The question then becomes one of what do we replace the US Treasuries with, to create an All-Weather Portfolio for Singaporeans that fits our risk appetite and investment objectives.
The way I see it, there are 3 possible replacements:
- Singapore Savings Bonds and Singapore Government Securities
- Ultra-safe blue chip dividend stocks and REITs
- Accredited Investor Bonds
Singapore Savings Bonds and Singapore Government Securities
This is the most straightforward one.
But there are 2 big drawbacks with Singapore Savings Bonds. Firstly, there is no potential for capital gains (the price of SSBs don’t go up even when interest rates drop), which actually takes away a huge benefit of bonds in a portfolio. Secondly, as the reader pointed out, each person is capped at $200,000 each. You can use your spouse’s and children’s and parent’s accounts of course, but that probably still caps you out around $1 million plus. If you’re looking at a $10 million portfolio, this is not going to be enough.
This leaves us with Singapore Government Securities. And the main drawback here is poor liquidity. These things barely trade on the open market. So you can buy a chunk at issuance, but good luck trying to sell them on the open market in a hurry, especially if you’re offloading big amounts.
Ultra-safe blue-chip dividend stocks and REITs
The next one is more interesting. In recent years, I’ve noticed that ultra-safe blue-chip dividend stocks and REITs like Netlink or Mapletree Commercial Trust have been trading in line with fixed income. So when global interest rates fall, these guys go up in price (yield drops), and vice versa.
Which led me to think, would it be possible to replace bonds with these bad boys?
The thinking goes like this. Imagine that I only care abut the dividend yield, and I completely ignore the day to day capital gains / losses. This way, the only thing I need to focus on is the underlying free cash flow. As long as free cash flow is stable and healthy, my dividend is sound, and for all intents and purposes, this functions as a bond to me.
In a big financial crisis, the prices may initially fall, but as long as underlying cash flow remains sound, the market will eventually recognise the true value and rerate their pricing. And outside of a financial crisis style situation, they have price action that allows them to function like a fixed income proxy.
Now I get that these aren’t perfect replacements for US Treasuries. But we’re already recognised there’s no perfect replacement right? So it becomes a case of what is the least bad alternative, and I can think of a lot of worse investments than a dividend stock/REIT with ultra stable underlying cash flows.
Accredited Investor Bonds (Yield spread of no more than 1.5%)
The final one of course, is not available to all retail investors. But the scenario here envisions a $10 million portfolio, which means that investment products available to Accredited Investors come into play.
The main asset class this unlocks, is corporate bonds that are only available to Accredited Investors. The minimum investment is $250,000 a lot, so even with a $10 million portfolio, they need to be used sparingly.
Now as the Spiderman Movie loves to remind us, with great power comes great responsibility. Just because your private banker is pushing all kinds of great bonds to you, doesn’t really mean they’re great. I’m not going to go into a full discussion of how to evaluate credit risk here (there’s the FH Course for you if you’re interested), but I’ll just simplify it into a simple rule of thumb. If the yield spread (the yield on the bonds compared to the 10 year Singapore Savings Bond) is more than 1.5%, you’re taking on real risk, and you need to closely evaluate what you’re buying.
Of course, just because something is below a 1.5% yield spread doesn’t necessarily mean they’re safe, but it does eliminate a big portion of the risky junk bonds. In this category, you’re usually looking at bonds from Government linked companies, which are safe enough to be considered for current purposes.
Unless you have a fantastic relationship with your private banker though, it’s still going to be tough to get the high-demand bonds. The big GLCs usually like to place to institutional investors first, and only the scraps go to Accredited/High Net Worth Investors. But it’s still worth a shot.
How would I invest $10 million?
So back to the original challenge. How do I invest the bond component of a $10 million All-Weather Portfolio, as a Singapore investor?
For obvious reasons, this should not be construed as financial advice. Please do check with your financial advisor or stockbroker before making any investments.
The bond component is split into 15% intermediate term bonds, and 40% long term bonds.
15% intermediate term bonds
My 15%, or $1.5 million, will go into a mix of Singapore Savings Bonds (up to the limit I can get access to), Singapore Government Securities, and any other retail bonds that comes my way (like Astrea IV/V or Temasek bonds). I’ll also consider topping up some money into CPF if that’s still an option. Any intermediate term (10 year or below) Accredited Investor style bonds I get access to come under here as well.
At today’s prices, realistically, this works out to around 2% to 2.5% yield, depending on how aggressive I get with the accredited investor style bonds, and how much Astrea/Temasek Bonds I get.
40% long term bonds
And now here’s the controversial part. For the 40% long term bonds, I’m putting them into ultra-safe dividend stocks or REITs that have super high visibility over long term cash flow. Locating them of course, is the hard part, and is what the rest of this site is for.
For me personally, the ones that I like enough for this purpose are: Netlink Trust, Mapletree Commercial Trust, CapitaLand Commercial Trust, and to a certain extent, Ascendas REIT.
Blending the 4 in equal proportions, creates a portfolio with a yield of about 4.4% to 4.7%.
If put the two portfolios together, 15% at 2 to 2.5% yield, and 40% at 4.4% to 4.7% yield, it works out a “bond” portfolio of about 3.9% yield.
Personally for me, I think that’s too much risk for the bond component of an All-Weather Portfolio. So what I would do, is that I’m going to mix some US Treasuries into the long term bond component to bring the down. If I keep 30% in the ultra-safe dividend stocks/REITs, and put 10% into a long term US Treasury bond fund like the TLT (about 2.25% net yield, 1.35% after withholding tax), the overall yield drops to about 3.4%.
But in doing so, I’m getting pretty large exposure to US treasuries, and all the qualities that comes with exposure to US treasuries. For me personally, I like the trade-off.
Financial Horse Dividend Yield Portfolio – For “Bond” Component of All-Weather Portfolio
Percentage of Total Portfolio
SSBs, SGS, Astrea/Temasek Bonds, Accredited Investor Bonds
2% to 2.5%
Blue chip dividend yield / REITs – Netlink Trust, Mapletree Commercial Trust, CapitaLand Commercial Trust, and Ascendas REIT
4.4% to 4.7
Long Term US Treasuries – TLT
1.35% (after withholding tax)
Writing this post made me feel like a chef. You know, one part sugar and two parts butter, mix well and add eggs?
But I think the real point of this article is to illustrate that the real world is not perfect. Investing in the real world sometimes requires making do with the best tools that are available to us at that point in time.
With a bit of creativity, and reasoning from first principles, we can construct an alternative dividend portfolio to suit our own risk appetite and investment objectives. I talk about this in much greater detail in the FH Course, so do check that out if you’re keen.
But for me, my “Bond” portfolio now yields about 3.4% yield, while striking a good balance between safety and returns. Throw in a 30% exposure to stocks, some gold and commodities, and the all-weather portfolio may be on its way to some pretty decent returns.
And by decent, I mean average, because that’s what this portfolio is designed to do. ?
What do you guys think of my modified all weather portfolio? Share your comments below!
Looking for a comprehensive guide to investing? Check out the FH Complete Guide to Investing for Singapore investors.
Support the site as a Patron and get market and stock watch updates. Big shoutout to all Patrons for their support!