August 2017 – Smart Money Asia

Asset Allocation for All Seasons

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Welcome back – I hope you had a great summer! It’s hard to believe it’s already almost September. The last four months of the year can be a busy time for investors. Many people have committed to targets earlier in the year, maybe in their New Year’s resolutions, for how much money they will put away or invest during the year, and suddenly the last quarter is looming. We all know that December is pretty much a write-off as you get busy preparing for Christmas and end of year holidays, so there are only really three months left to take action.

It’s been a pretty eventful year, not to mention a volatile summer. At one point in August the VIX Index, otherwise known as the fear index, surged by 62% in three days. (Bloomberg) A person with money to invest right now is looking at a constant stream of rather off-putting news: North Korea, terrorist attacks, protests in the US, Brexit, oil prices slumping again, not to mention central banks mulling major monetary policy decisions. So how on earth do you choose investments at a time like this?

Once again we need to go back to basics and build a core portfolio that can withstand the risks a fast changing world can throw at it. A lot of people already get the concept of spreading their risk around, not having all their eggs in one basket, but are perhaps unsure of exactly how to achieve this. Today we will look at some advice from an expert.

Ray Dalio is the founder of Bridgewater Associates, the world’s largest hedge fund with some $150 billion in assets under management. Coincidentally, while I was drafting this post, I found this article in the Financial Times quoting the man himself on a rise in risk in the current climate. Needless to say, his opinion is highly sought after.

Tony Robbins interviewed Dalio for his book MONEY Master the Game: 7 Simple Steps to Financial Freedom and asked him how regular investors should organise their portfolios. His advice is both simple, and easily implemented:

According to Dalio there are four things that move the price of assets:

Inflation
Deflation
Higher than expected economic growth
Lower than expected economic growth

Also, there are only four economic environments, or seasons, that will affect asset prices:

Higher than expected inflation (rising prices)
Lower than expected inflation (deflation)
Higher than expected economic growth
Lower than expected economic growth

Unlike the four seasons we associate with nature, these seasons do not necessarily come in order, and it is difficult to predict how long a season will last. Each asset class will fair differently depending on the prevailing season. Therefore Dalio says we should have 25% of our risk in each of the categories. His strategy is known as All Weather, and ensures the portfolio is covered, regardless of what season comes next.

Dalio breaks down which assets will perform well in each of these seasons:

Higher than expected inflation – commodities / gold, inflation linked bonds
Lower than expected inflation – government bonds, stocks
Higher than expected economic growth – stocks, corporate bonds, commodities / gold
Lower than expected economic growth – government bonds, inflation linked bonds

Tony Robbins persuaded Dalio to simplify this into an asset allocation that individual investors can follow. It’s called the All Seasons strategy and it looks like this:

30% stocks
15% intermediate term bonds (7-10 year)
40% long term bonds (20-25 year)
7.5% gold
7.5% commodities

This portfolio could easily be constructed with a low cost portfolio of ETFs, as suggested in this article. (a year old but see the ETFs listed in the middle of the article)

Many people are surprised by the high allocation to bonds, but Dalio points out that stocks are three times more volatile than bonds, therefore the damage they can do in the wrong environment needs to be controlled. Most investors have their asset allocation set up to do well in a good market, but very badly in a bad market.

He also points out the importance of rebalancing annually so you do not get out of balance when one segment does particularly well. I would also stress, for the international investor, the importance of establishing your base currency to control currency risk over time.

So, if you are looking to add to your investments over the coming months, make sure you are considering your asset allocation carefully and set yourself up to thrive in all four seasons.

Disclaimer: This should go without saying, but the information contained in this blog is not investment advice, or an incentive to invest, and should not be considered as such. This is for information only.

Lump Sum Investing – Offshore Platforms

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Today let’s take a look at a simple lump sum investment vehicle. These are often referred to as platforms or wrap accounts. There are a number of them available these days, each with different features, but we’re not going to try to compare one with another here, just to give an overview of how they work.

First of all, these products are for lump sum investment. If you are not sure what we mean by lump sum, please read this. Minimum investment levels will differ, but around USD 25,000 is typical.

Structure – The typical structure for these investments is a nominee account, whereby the assets are held by a nominee company set up by the platform provider. Investor assets are segregated from the provider company assets and the individual investor is the beneficial owner. Compared to investing directly in the underlying funds costs are reduced due to bulk trading and settlement is quicker.

Security – the nominee account structure ensures that if anything were to happen to the platform provider as a business, the investor assets are held separately. If one of the underlying funds falls in value or fails, then capital is of course at risk.

Jurisdiction – offshore platform accounts are typically set up in Isle of Man, Guernsey, Luxembourg or an equivalent tax efficient jurisdiction.

Tax – as the accounts are set up offshore, no tax will be deducted from the investment “at source”. Account holders are of course responsible for reporting the investment in the country they are tax resident in.

Investment options – Platform accounts can be either open architecture or menu-driven. Open architecture means you can own pretty much any publicly traded financial asset, which would include direct stocks, bonds, ETFs and mutual funds. Menu-driven platforms will have a fixed menu of mutual funds to choose from, and some of them will also have a menu of ETFs. Platform accounts are also likely to have access to a number of “managed portfolio” investments. These portfolios are managed by an investment manager and can invest in a diversified range of assets, many of which may not be on the platform menu itself. They are usually managed in a base currency, to a specified risk profile. So a USD Growth portfolio will have USD as it’s base currency and will invest in a range of cash, bonds, stocks, funds, ETFs and alternative strategies. The manager will have control over the underlying investments and will likely rebalance them on a regular basis.

Distribution – offshore platforms are typically distributed through financial advisers.

Fees – fees will vary from one platform to another. Typically the platform provider will take 0.5% upfront on money invested and 0.5% per year. The financial adviser handling the account may then add an upfront and annual fee on top of that, which may be negotiable depending on the investment amount. Mutual funds and ETFs on a platform will typically deal at NAV, which means there is no initial fee. Usually there are no redemption fees / exit penalties and all money can be withdrawn any time with reasonable notice.

Drawbacks – although you will be able to view your investment online, not all platform accounts allow online “trading”. They are not brokerage accounts and in some cases you will have to submit a signed instruction in order to buy or sell assets. The idea is that you should be discussing your investment strategy with your adviser and making long term asset allocation decisions, not trading assets day to day.

Platform accounts can be an efficient and cost effective lump sum vehicle. They also tend to offer significant diversification. This means it is possible to establish a solid core/satellite approach, whereby the majority of the investment is in a well diversified portfolio and a smaller percentage is invested in more alternative or riskier assets.

NISA – The Japan Individual Savings Account

Today let’s take a look at a Japan based investment vehicle that longer term expats may wish to utilise. The Nippon Individual Savings Account Program, or NISA, was launched in January 2014. It has since been expanded to include the Junior NISA. NISA is based on the UK Individual Savings Account. (ISA)

Eligibility – anyone over the age of 20 resident in Japan is eligible to open a NISA account.

Tax Exemption – individuals are eligible for an exemption of the 20% levy on income from capital gains and dividends from annual investments of up to ¥1.2 million made over a five year period, as long as they reside in Japan. In other words, you can contribute up to ¥1.2 million in year one and it is sheltered from tax on gains for 5 years. You can then invest up to ¥1.2 million in year two and that is also tax free for 5 years, and so on. Each annual “slice” qualifies for the 5 year tax exemption. So if you invest every year you can hold one NISA for a total of 10 years. After that you may start a new NISA.

Junior NISA – available since April 2016, Junior NISA allows parents / grandparents / guardians to make contributions on behalf of children under 20. The contribution limit for Junior NISA is ¥800,000 per year.

Investment options – NISA’s are offered by securities companies. This means you are able to invest in direct stocks, bonds, ETFs and mutual funds.

Security – as the account holder directly owns the investment assets in the account, NISA’s are very secure. Of course you are still taking investment risk and there is no protection against the value of investments falling.

Cost – it’s tricky to find information on the actual fees involved in investing in NISA, but they are relatively low. The securities company will charge a brokerage fee of up to 0.15%, usually with a minimum commission fee. ETF management fees are no more than 0.5% p.a.. Mutual funds run around 1.5% p.a. Obviously costs will increase if you employ an adviser to help you with asset allocation.

Drawbacks – one drawback is that capital losses made in a NISA cannot be used to offset against capital gains made in other accounts, but this seems fair enough on a non-taxable account. The main drawback with NISA is that if the value of your investment falls over the 5 year investment period, the price is effectively reset and any recovery then counts as a taxable capital gain.

Let me illustrate that so it’s clear: Say you invest ¥1.2 million in your NISA and leave it there for 5 years. Over the 5 years the value falls to ¥800,000. You don’t want to sell the asset and realise the loss, so you continue to hold it. However, it is now outside the 5 year tax exempt period. If the value then returns to ¥1.2 million you will be taxed on the ¥400,000 “increase” as a capital gain.

Account Opening – the account opening process is a little convoluted and you are going to need some skill / help in Japanese language to complete it. Typically the flow is something like this:

On your chosen securities company website, request the account opening documents for NISA – this will require inputting some personal information.
Account application documents will be mailed to you.
Complete account application documents and return along with a copy of your residence card and tax ID number. (My Number)
The securities company will then apply on your behalf to the tax office.
The tax office approves the application and notifies the securities company.
The securities company then notifies you that the account is open, either by mail, or via login to their website.

Some well known securities companies offering NISA are Rakuten Securities, SBI Securities and Matsui Securities. As far as I’m aware, the online interface for applying for accounts, depositing money, and buying / trading investments is all in Japanese.

This article suggests that, even for Japanese people, setting up Junior NISA is rather complicated.

Overall, NISA seems like a very cost-effective way to save and invest in Japan. However, I do feel that the major hurdle for expats is the lack of an English interface. Also for expats and Japanese alike, operating a securities account without professional advice, whether tax exempt or not, means managing your own investments. Some people will relish this level of control, while for others it can be rather daunting. Hopefully that’s where this blog will come in useful! You may want to go back and work on your financial profile and read up on the investment basics in earlier posts.

Property Investing Part Three – Money in, Money Out, Asset for Free, Income for Life

Welcome back to part three of our series on property investing with Graeme. In this installment he shows us how to use mortgages to our advantage:

Above is the number one mantra of a professional property investor, and if you want to build a successful portfolio it really helps to know how you can get a property for free and income for life.

Property is a major route to life-changing wealth and the main reason is because you can use other people’s money to make money. Even if you use your own money, an important point is how you buy a property and get your money back whilst making a rental profit each month. In many countries, (UK, USA, Canada, Australia, New Zealand etc.) not only can you pull your money out of a property by remortgaging and make a monthly rental income, you can also increase the property’s equity over time.

Money Out with a Mortgage

The principle of money in money out works because of mortgages. Mortgages are available in all countries, however the calculation to find money in money out deals may vary slightly from one country to another. For example, in the UK we focus on getting our money spent on a property back in 6 months because this is the legal amount of time it takes to get a remortgage after purchase. In other countries this time frame may be slightly different, however the basic principle of using mortgages (the bank’s money) to return your personally invested money is the same around the world.

To use the U.K. example, whenever a serious investor analyses a property he or she asks the question:

What is this property worth, refurbished to a good standard in 6 months time?

We want to refurbish properties to a good standard because the mortgage company will increase the loan amount and six months after purchase we can get all our invested money out of the property. Furthermore we want to refurbish a property to a good standard because we want to be good landlords – property is a people business and a good property attracts good tenants who stay longer and pay full rent on time. Initially it costs more to refurbish a property to a good standard but in the long run this is the smart business thing to do.

So how do we know what is a money in money out deal? This is best explained with an example:

Money In Money Out Example

Lets say we find a property on the market and comparables suggest it is worth 100K in good condition. To keep things simple and based on standard UK mortgage lending we will assume a loan of 75% to the value of the property.

If we want to get all our money back we do a simple calculation:

100K x 75% = 75K (loan amount)

– refurbs e.g. 5K

– other costs 2K (legal fees, survey)

= 68K

So we know our maximum offer to the seller is 68 K and we can invest a total of 75K if we want to get all our money back on the remortgage.

With this example let’s assume we have the 75K in savings and our offer of 68K is accepted. We buy the property for 68K, pay the survey and legal fees and refurbish the property with 5K. Then 6 months later, when the property is already rented, we take a remortgage and the mortgage company’s surveyor looks for comparables in the area and finds the fair market value is 100K, and because most UK mortgage companies give 75% of a property’s value, they give us 75K and hey presto we now have the 75K spent back in our bank account.

Comparing Apples with Apples

“How do we find good comparables?” you may ask. “How do we know the true value of a property?”

Well, we have to think like a surveyor because surveyors are the people who actually put the values on properties.

A surveyor looks at similar properties that have sold in the same area recently. In the U.K. we use websites such as nethouseprices.com, mouseprice.com or ourproperty.co.uk as these websites use Land Registry data. (the organization which stores official property title deeds)

Specifically we want to know if anything has sold within the last 6 months that is very similar to our property, in particular comparables should have the same number of bedrooms. Ideally these comparables are in the same street. If not the same street then within ¼ of a mile, and if not then expand your search out further which is easy to do when you input your information into a property website’s search engine.

Look for properties in a high price range and in good condition.

If the comparables are a bit tired or fully distressed call 3 estate agents and ask for an honest appraisal and take the average of the 3 predictions. Another method is to call a local surveyor and ask “What will this property value at in the current market, once refurbished?”

To be extra safe you can use all the techniques together and take the average.

The Power of Persistence

Now, one mistake amateur investors make is believing the seller’s asking price. Our research tells us the value of our example property is 100k after refurbishment, however the asking price might be 110k or 130K or 90K or whatever the seller thinks it is worth. The only thing you need to remember is: The asking price is irrelevant!

Of course you may say, “This is all very interesting but no seller will accept such a low offer” and you would be right that it is unusual. However it is possible, and successful investors actively search for such below market value (BMV) deals.

Property investing courses say that 1 in 40 such BMV offers are accepted. The truth is it depends on the market. It might be 1 in 60 BMV offers in a buoyant market, but when sellers are desperate you might only have to make 20 such offers. The point is there are motivated sellers in every market and professional investors have a variety of ways of finding them.

As you can see you will have to experience a lot of rejections in order to get a real BMV deal. You will have to kiss a lot of frogs to find a prince. Amateurs hate rejection but it is part of the game, and if you don’t embrace rejection it may crush you to the point of giving up. However, just because someone says “No” it does not mean they won’t say “Yes” at a later date. If a seller rejects your offer simply record the offer in your property database and move onto the next property. Then 3 weeks later re-offer. You will probably offer 3 or 4 times on the same property and that is fine. Your database is a simple chart that shows property address, offer, date of offer, refurb estimate and rent per month. Your database is a simple, powerful tool that will grow and, given time, help you find good BMV deals. Remember to put all your offers into the database because as my mentor likes to say, “The money is in the database”.

The number one mantra of a professional property investor is:

Money in, money out, asset for free, income for life.

In the next article we will examine the final piece of the mantra i.e. how to get rental income for life, even while paying a mortgage on the property. For now however, let’s summarize this piece which has focused on getting your money out of a property and gaining an asset for free.

Summary

Research and make many BMV offers
Buy BMV
Refurbish
Roll onto long-term finance with a bank.

The Offshore Regular Savings Plan

So here is a first look at a well known investment product. I’m going to start here as these plans have been around for a long time, and have been known to generate lively discussion. They are in the toolbox of almost every expat financial adviser / salesperson worldwide and millions of dollars, pounds and euros flow into them every year. They are also somewhat controversial products as they have sometimes been abused by unscrupulous salespeople, selling them to (in some cases lazy) customers, who don’t read the terms and conditions.

Regular savings plans are offered by a number of life companies, with the most common being RL 360, (Royal London), Friends Provident International, Old Mutual International, Generali Worldwide and Zurich International Life.

Structure

The typical structure for this product is an offshore unit linked insurance policy. Offshore means it is domiciled in a tax free jurisdiction such as the Isle of Man or Guernsey. Unit linked means that contributions are used to buy units in investment funds. A unit linked plan acts like a savings vehicle, but it also has the benefits of an insurance contract. The insurance part comes from the 101% (of policy value) death benefit attached to the policy. Although many of these contracts are now issued on a capital redemption basis, whereby there are no lives assured and the contract can be passed on to future generations. Capital redemption products have a slightly confusing 99 year maximum term, which facilitates the passing on of the investment to future generations – you do not have to keep it in force for 99 years though!

Typically these contracts are set up with a fixed savings term, usually aligned with the investors savings goal, such as their retirement age. If the policy is surrendered before this savings term is reached, early surrender penalties apply.

Security

The Isle of Man and Guernsey regulators each operate a policyholder protection scheme. In Guernsey insurers are required to hold assets representing at least 90% of liabilities in trust with an independent trustee. The Isle of Man Policyholder Protection Scheme levies all insurance companies operating on the island to pay into a Policyholders Compensation Fund, which will pay out a sum equal to 90% of the liability if an insurer is unable to meet it’s liabilities.

Note: What we are talking about here is protection if the insurance company itself “goes under”. In practice this is highly unlikely. If one of these companies started to get into trouble, it would most likely be swiftly bought out by one of it’s competitors and policyholders would be unaffected. Also, policyholder protection does not protect from losses in the underlying funds. If the fund goes down in value, so does your policy. If the fund itself fails, then your capital is at risk.

Uses

Regular savings plans are typically used for saving for retirement or for children’s future education costs. Moreover they are popular with people who feel they need to get started saving and perhaps need some discipline to do so. Although it is getting much easier these days, it used to be quite difficult for expats to find an investment vehicle where you could invest a small amount of money each month and still be able to diversify into a range of asset classes. High investment minimums or high transfer costs would prevent the smaller saver from getting started. The ability to make automatic monthly collections from the customer’s credit card made all this easy, the money would simply be deducted every month and the investor didn’t have to go to the bank and send it. When you consider that in Japan, for example, making a $300 overseas bank transfer can cost up to $40, not to mention the time spent in the bank actually getting it done, credit card collection made these products easily accessible.

Fees and charges

The fees on these policies are relatively high. And with the advent of low cost brokerage accounts and ETFs it is getting harder to justify the cost of one of these vehicles. A typical fee structure looks something like this:

Initial unit charge: 1.5% per quarter, charged on contributions made in the first 18 months for the life of the policy.

Administration charge: 1.5% per year applied across both initial and accumulation units

Policy fee: A fixed fee, usually around $8 per month

These are the basic fees applied to the policy itself. The underlying investment funds also have their own management fee, which is typically 1.5% per year. There are generally no initial fees for accessing the funds.

These products are not sold directly by the life companies. They are distributed via financial advisers. The initial unit charges are largely used to pay commission to the adviser.

Usually these policies offer some kind of extra allocation as an incentive to get started, or a loyalty bonus to incentivise saving for the long term.

Investment Options

The investment choice for these products is menu-driven. This means there is a fixed range of funds to choose from. These are mostly managed funds (mutual funds) and cover the full range of asset classes. You cannot access ETFs in these plans at present, although there are an increasing number of index tracker funds available. Switching between funds is free of charge.

Currency

Typically these plans are available in GBP, Euro and USD. Some accept contributions in JPY. In most cases, once you have selected the contribution currency, it cannot be changed. This means you need to think carefully about your base currency before getting started. Funds are available in multiple currencies, which is one way you can mitigate currency risk if need be.

Tax

As these policies are domiciled in “tax havens”, they are not subject to income or capital gains tax in those jurisdictions. This means they will grow without any tax being deducted at source. It does not necessarily mean that they are tax free for policyholders, as that will depend on their nationality, where they reside, and their own personal tax situation. Offshore life products were originally designed for British expats, and carry several potential benefits for them, even if they return to the UK with the policy. These include a 5% withdrawal allowance, time apportionment relief, top slicing relief, and clustering and segmentation. (I’m not going to get into the details here as this post will already be long enough as it is)

One of the benefits of these international schemes is that they are “portable”. It’s easy to move from one country to another without affecting the investment itself, although it’s important to note that a policyholder’s tax situation may change when they move.

Do’s and Don’ts

Despite the high fees, these products can still be an effective long term savings vehicle if used properly. The most important thing here is to understand how the contract works and avoid the pitfalls.

There are two types of units associated with these policies: initial units and accumulation units.

Initial units are units purchased during the Initial Allocation Period (IAP), which is typically 18 months, but can vary. These units are charged at a higher rate and must stay invested until the end of the selected savings term. If these units are withdrawn early, an early surrender penalty will apply. That penalty starts off large and gets smaller the closer you get to the maturity date.

Accumulation units are those purchased after the IAP. They are charged at a lower rate and can be withdrawn without penalty if necessary.

Once you have completed the initial unit allocation period, you have the option to reduce contributions, or take a break from contributions for a while.

DON’T mistake one of these products for an 18 month savings plan – if someone explains it to you as such, run a mile.

DON’T start with a higher premium level than you plan to contribute for the whole of your chosen term. One of the worst ways to use a plan like this is to start off contributing say $4,000 per month, and then reduce it to $300 per month after the IAP. You just end up paying high initial fees on the original amount in order to get a $300 per month savings plan.

DO start with an initial contribution amount that you are comfortable making for the whole investment term. This is the most efficient way to use these plans. The flexibility to take a break from paying premiums is there but it’s far better not to use it. Increasing contributions generates a new IAP on the increased amount and new initial charges, but you are not penalised for it. Reducing / stopping premiums effectively comes at a price.

DO read the product literature, especially the parts about fees and charges, the IAP, and maturity dates. Take responsibility for understanding the investment before you get started.

That said, if you are considering investing in one of these schemes, you are likely talking to a financial adviser. This is a long term investment and the adviser is well paid for it, so make sure you are talking to someone you think you can work with for the long term. How long have they been around already? Are they likely to stick around? Are they qualified? Do they have a plan for how to manage one of these policies through the three stages of capital accumulation, diversification, and pre-retirement? (See here)

NOTE: If you have one of these plans already, and you didn’t really understand it when you started, your “adviser” is no longer around, and you are not happy, consider your options carefully. I have seen blanket online advice that you should quit immediately and take the hit, or withdraw as much as you can to reinvest in something cheaper. These things should be considered on a case by case basis, depending on what your maturity date is, how much you have contributed so far, and how much you are able to contribute going forward. You should also be considering what funds you hold, how they’ve performed, and whether now is a good time to be selling them or not. Find an adviser you can trust before making any hasty decisions.

Summary

It’s very easy to write these plans off and say “you should just invest in a portfolio of ETFs and only pay 0.5% per year in fees”. While I certainly don’t disagree with that strategy, some people simply do not find it that easy to implement by themselves. If used for reasonable investment amounts as a long term savings vehicle these products can be simple and effective. I have seen them make decent returns over the long run when used properly. However, they are certainly not for everybody and should only be implemented after careful consideration.