Tuesday, December 21, 2010

A Year Older, but None the Wiser?

What a year it has been! Liquidity remains abound and asset prices, particularly that for real assets, have continued to remain resilient.

It is also looking like a bifurcated world; in terms of growth prospects and asset prices for the developed and emerging economies. That said, never forget that the entry price is vital in determining investment return regardless of how rosy economic prospects can be. If it is already in the price, the return is likely to be mediocre.

Despite these peculiar market conditions, MOS feels value investing remains the way to go although having an idea of the macro picture is tantamount to avoid big mistakes.

Several of the stocks profiled have continued to perform. Whilst its investment into a REIT remains questionable, Innotek remains above the March 2010 price. It also appears on track to pay out another 5 cent dividend.

We all like companies which we can hold through cycles. But by and large, we are not "buy and hold investors" because very few firms possess the competitive advantage to merit investors holding them through market cycles.

For firms in cyclical industries, it is paramount to know when to exit before things go pear shaped. We continue to like Innotek because it yields 10% at our entry price and remains under NTA. That is not to say that we would not hesitate to trim/exit the position when the price-NAV gap shrinks. Likewise with Asia Enterprise Holdings. Trading at S$0.27 on the Singapore Exchange, it has grown its NAV and has a very long track record of profitability. Mindful of the fact that it operates in a cyclical industry where demand can vaporize quickly, management has prudently maintained a strong balance sheet. Trading under NTA, it offers a good 4-5% yield at current price. MOS also see a potential catalyst in the coming year. Investors have placed bets on Keppel and Sembcorp Marine on potential large contracts from Petrobras. Placing money in Asia Enterprise which derives a significant chunk of its revenue from the local marine industry is a bet on both horses. Seems to be a two in one proposition which we could live with. Unfortunately we cannot delve into details for more portfolio holdings or provide more update for this is meant to be a strategy piece.

The high yield of Innotek brings us to the next characteristic which exemplifies our portfolio - importance of dividends. To go to the upcoming Christmas cocktail party and tell people that you are into dividends instead of the next solar stock may not make for exciting conversation. However, for excitement and attention, we recommend you put on a loud red, green and pink garish outfit and stick to picking out high yield names. In markets with increased volatility, MOS feels that going for yield will make a significant difference in the long run.

Besides the obvious reasons where it is usually companies with good strong business models or excess free cash flow which can afford dividends, it is not usually highlighted that dividend income makes up approximately 30% of total return in many global studies over extended periods of time. So with reports suggesting that the recent whipsaws in markets are unprecedented, having high yield as a cushion is a strategy which MOS is pursuing. Not rocket science, not the most sexy but one which being a hare could far outstrip the rabbit if the return on capital is sensibly compounded.

The market volatility also brings into spotlight arbitrage techniques. Capital structure arbitrages, TDR/cross listing trades, spin-offs are event driven techniques which are independent of market direction. Hence, their contribution to the overall portfolio return is important if market is directionless. So investors should actively seek opportunities like Lion Asiapac where the return is more dependent on corporate events rather than broad market movement or sentiment.

Another year has flashed by but the market prognosis remains challenging. The future will always remain inherently uncertain. The fundamental concepts of value investing may be simple but no one would say that applying them is easy.