Month: January 2016

Snowball Blessing Structure

4 months ago I wrote “The Snowball Blessing Manifesto“, outlining my philosophy that those who are engaged in the game of compounding wealth are the lucky few and as a result we have a moral obligation to give back to society using the power of compounding.

But it was just an abstract concept. I didn’t really know in what shape or form I wanted to bring good to society through the power of compounding.

That was until I had one of the most mind blowing conversations ever yesterday that revolved around political theory and philosophy.

Now the path is much more clear.

To me, one of the most important issue that faces humanity is the survival of humans as a species if we were to stay on planet Earth. It’s why Elon Musk thinks humans need to be a multi-planetary species if we are to survive as a species, and I wholeheartedly agree and support him on this endeavor.

But more importantly, in order for humanity to survive until we become a multi-planetary species, we need to also ensure the effects of climate change is either delayed as long as possible (if pessimistic) or eliminated completely (if optimistic).

That’s where I think Snowball Blessing comes into place – To improve the probability of human species’ survival through the pursuit of sustainable energy which helps delay / eliminate the effects of climate change.

Which coincidentally makes Snowball Blessing take up a different meaning. Not only does Snowball symbolize compounding, it now also symbolizes the combating of climate change so that future generations can enjoy things such as snow during the winter or up in the high mountains.

And to achieve this goal, I think setting up Snowball Blessing as a charity trust is way too limiting in terms of choice of endeavors that the trust can engage in, but also the limitations of being hands on with such endeavors as well.

Instead I envision Snowball Blessing to look more like this:

Snowbal Blessing

Where Snowball Blessing is a holding company which has three subsidiaries, namely:

  • Snowball Ventures which focuses on investing in and growing startups (branding / strategy) that are focused on sustainable energy
  • Snowball Fund which focuses on investing in (stocks) or lending (bonds) to public companies that are focused on sustainable energy
  • Snowball Philanthropy which focuses on donating to non-profits that are either focused on advocacy of a sustainable environment or focused on spending donations to directly improve environmental sustainability

In terms of the source of funding, it would be from my personal investment portfolio instead of being structured in any corporate form either than possibly a limited partnership. This allows for the maximum freedom in terms of asset class and region, but also allows me to invest with an extremely long time horizon as I would possess patient capital.

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The Beauty of Samuelson Share

By Paul_Samuelson.gif: Innovation & Business Architectures, Inc. derivative work: Bender235 (Paul_Samuelson.gif) [CC BY 1.0 (http://creativecommons.org/licenses/by/1.0)], via Wikimedia Commons

Reading Lifecycle Investing by Ian Ayres and Barry Nalebuff and stumbling upon the Samuelson Share finally solved my dilemma of finding a market timing mechanism that could give me a signal of when to hedge with cash and when to leverage to invest.

This to me is important because many investors I admire (Charlie Munger, Howard Marks, Seth Klarman, Warren Buffett) all talk about the importance of holding lots of cash to take advantage of once in decades type investment opportunities.

Which if I were only dealing with the decision of deploying cash or holding cash, the Shiller P/E or Warren Buffett Indicator (Total Market Cap / GDP) would suffice.

The problem with either indicators is the inability to introduce leverage into the equation of investing. They can give you a signal that it’s a great time to leverage to invest, but they don’t give you a good specific number of how much to leverage to invest.

That’s where Samuelson Share comes into the picture. Samuelson Share indicates the % of your lifetime savings you should invest in at any given moment if you mix it in with Shiller P/E. Thus at the early stages of your life you’d most likely have to leverage to a maximum of 2:1 if you wanted to fit the bill with the Samuelson Share recommendation.

And the beauty of Samuelson Share if used with Shiller P/E is it gives a very good picture of when to invest or not, because it also utilizes the Volatility S&P 500 Index. So not only you have Shiller P/E giving you a proxy on valuation levels, you have Volatility S&P 500 Index giving you a proxy on whether all the panic selling has been done yet [1].

But I use the Samuelson Share indicator even more aggressively, I will go with the more aggressive allocation recommendation when comparing % of lifetime savings recommendation [2] with % of existing savings [3]. The rationale of using the more aggressive allocation is that if you are going to use leverage when the Shiller P/E and Volatility S&P 500 Index screams that it’s a once in decades type investment opportunity, you should go hard or go home. [4]

That’s why Samuelson Share is really beautiful in my eyes. At 16.5% Samuelson Share (24.56 Shiller P/E, 20.20% Volatility S&P 500 Index, 2 RRA), I just feel very comfortable holding 83.5% of my net worth in cash. I might look very stupid over the next few years for losing to the market due to a ridiculously high cash hedge, but as Charlie Munger says, “The way to get rich is to keep $10 million in your checking account in case a good deal comes along…There are worse situations than drowning in cash and sitting, sitting, sitting. I remember when I wasn’t awash in cash — and I don’t want to go back.” [5]

[Footnotes]

[1] Theoretically, the higher the Volatility S&P 500 Index, the more fear there is in the market, and the more panic selling there should be as a result. There is no point in being in a hurry to buy something that is fundamentally cheap if you’re sure it will get fundamentally cheaper because of market irrationality.

[2] (Samuelson Share % * Lifetime Savings / Years until Retirement)

[3] (Samuelson Share % * Existing Savings)

[4] Even though I’m going to go hard when it makes sense, the maximum leverage I’m willing to go is only 2:1 (Assets to Equity, which is equivalent to 1:1 Debt to Equity). This minimizes the chance of blowing up while taking advantage of the benefits of leverage.

[5] I’m nowhere close to having $10 million, and most people who are reading this are in the same situation, the same principles apply. If there’s no compelling time / opportunity to deploy your hard earned cash, hold it and be patient.

[Disclaimer]

Not advice. No offer. Do not rely. May lose value. Risky. Conflicts hidden/obscured. (Borrowed from Terrence Yang‘s Disclaimer on Quora)

Patience My Friend… Patience

By Creator:Jan Gotard (artyzm.com) [Public domain], via Wikimedia Commons

My trigger finger’s itching.

With the Hang Seng Index’s P/B below 1.0 for the first time since 1998’s Financial Crisis, dollar cost averaging into Hang Seng Index just seems like a very good idea, considering how Hang Seng Index’s P/B never went that low even during 2003 SARS epidemic, 2008 Financial Crisis and 2011 European Sovereign Debt Crisis.

But I have to keep asking myself, “What’s the better alternative to investing money into the Hang Seng Index today?”

And I think there are a few things to consider when asking that question:

Hang Seng Index is cheap based on historical P/B or even CAPE (cross-reference current CAPE of 14.9 versus historical average CAPE of 18.6), but the only ways to unlock value (ever-improving fundamentals, positive sentiment, dividends) don’t look promising overall.

Hang Seng Index is not very moaty. Of the 50 constituents, the only Wide Moat company is Hong Kong Stock Exchange according to Morningstar. This relates to the ever-improving fundamentals and positive sentiment points aforementioned as Hang Seng Index’s constituents will have a tough time growing earnings let alone maintaining earnings during tough economic conditions, which ultimately would make sentiment bad and drag price multiples down.

The only positive side is the dividend part of the equation.

The historical average of 30 Year US treasury yield is 5.45%. The implied current month-end weighted average dividend yield of Hang Seng Index is 4.77%, which means Hang Seng Index only needs to grow dividends 0.68% to perpetuity to match 30 Year US treasury’s historical average yield.

However, Hang Seng Index has precedence of cutting dividends when things are rough (Tracker Fund of Hong Kong’s dividend dropped from $0.68 / share in 2008 to $0.54 / share in 2009). If we assume Hang Seng Index will cut dividend yield double the rate from last time’s cut (20.59% to 41.18%), then Hang Seng Index’s discounted dividend yield is 2.8%. Considering that Hang Seng Index only needs to grow dividends 2.65% to perpetuity to match 30 Year US treasury’s historical average yield, it doesn’t seem too hard considering Hong Kong’s average inflation rate of 4.51% from 1981 to 2015.

But compare that to my alternatives, Hang Seng Index looks bad.

I always compare every investment to Berkshire Hathaway, since I think it’s the moatiest company out of the 186 Wide Moat stocks listed in the US, rated by Morningstar and evaluated by me.

And there is no way the Hang Seng Index is more attractive than Berkshire Hathaway, even with today’s valuation.

Berkshire Hathaway’s P/B is currently 1.24 ($125.62 share price / $101.23 book value). Even if we take the most conservative book growth CAGR from the past 1 year, 3 year, 5 year and 8 year growth (which is 10.31%) and discount the P/B to the buyback floor of 1.2 P/B set by Warren Buffett, you’re still looking at a 9.98% return based on growth alone.

That just crushes anything that the dividend side of Hang Seng Index can offer.

In terms of the moatiness of Berkshire Hathaway, it’s very hard to find any company that can top it. If subsidiaries are to Berkshire Hathaway what constituents are to Hang Seng Index, then there’s no competition as many Berkshire Hathaway subsidiaries posses wide moats even if they were stand-alone businesses.

This allows Berkshire Hathaway to unlock value through the ever-improving fundamentals protected by its wide moat, which also allows for a better chance for positive sentiment to find favor with Berkshire Hathaway over time.

So all I can say is, patience my friend… patience. Think things through by challenging decisions and assumptions through calculations and you might find a different picture that would save you from a world of hurt.

[Disclaimer]

Not advice. No offer. Do not rely. May lose value. Risky. Conflicts hidden/obscured. (Borrowed from Terrence Yang‘s Disclaimer on Quora)

The Relationship Between Macro Conditions, Affordability to Lose and Investment Style

By No machine-readable author provided. Mohylek assumed (based on copyright claims). [GFDL (http://www.gnu.org/copyleft/fdl.html), CC-BY-SA-3.0 (http://creativecommons.org/licenses/by-sa/3.0/) or CC BY-SA 2.5-2.0-1.0 (http://creativecommons.org/licenses/by-sa/2.5-2.0-1.0)], via Wikimedia Commons

I keep catching myself with the thought that I would invest differently if I were to be financially free.

If I weren’t financially independent, I couldn’t afford to lose the capital in pursuit of growth as it’s much harder to gain back percentage wise any losses (eg. 50% loss requires 100% gains to recover). If I wanted to become financially free by my early 30s, every step had to be careful to not lose capital.

This is the reason why I’m so attracted to Wide Moats. If analyzed and diversified properly, a portfolio of Wide Moats are structurally designed to survive recessions and continuously increase intrinsic value over all stages of an economic cycle.

The downside to this strategy of course is that your returns are capped. You can still beat the market, but not by much, since Wide Moats are usually well known large / mega cap stocks covered by tonnes of professional equity analysts, the opportunity of a Wide Moat misprice is usually few and not significant in magnitude.

So if a recession hits (Macro Conditions), in exchange for capped returns with a Wide Moat strategy (Investment Style), you won’t get wiped out (Affordability to Lose).

But what if I was financially free? How would I invest differently?

I would invest any excess money beyond the Wide Moat stock portfolio required to stay financially free into any type of asset that is well known for misprices (net net stocks, spin offs, merger arbitrage, distressed debts etc.).

The biggest risk to investing in assets well known for misprices is being wiped out when macro conditions sour. That’s the reason why I’m uncomfortable to invest in these assets while I’m trying to become financially free.

Assets well known for misprices are usually structurally not designed to outperform the markets if held for too long. The usual reason why the huge misprice existed in the first place was because structurally there must be something wrong with these assets, and that negative sentiment of these assets went way overboard.

The only way to make money from these assets thus is through a hit-and-run (buy when significantly cheaper than intrinsic value, flee at first sight of market price and intrinsic value merging).

So when a recession hits, these assets most likely die (eg. bankruptcy). If your portfolio was completely filled with these, you’d be screwed.

One way to remedy this problem is to hold lots of cash when opportunities are scarce. But a diligent investor will always find a mispriced opportunity if your investing scope is unlimited geographically and asset classes.

And even if you applied cash hedging strategies that took into account macro conditions (eg. hedge % of portfolio in cash based on Shiller P/E, Stock Market Cap / GDP, Samuelson Share), you’d run into the trouble of position sizing since how much you invest in each position.

Obviously, when hedging based on macro conditions, the amount of money you can invest varies literally day to day, so it gives you tremendous headache with position sizing as you have to figure out how much money you can invest divided by how diversified you want your portfolio to frequently.

So the only way I can find investing in assets well known for misprices working (Investing Style) is if you’re absolutely fine with losing the money dedicated to this strategy (Affordability to Lose) so that you can be fully invested regardless of economic cycles (Macro Conditions).

So until I’m financially free, I’ll stick to Wide Moats.

[Disclaimer]

Not advice. No offer. Do not rely. May lose value. Risky. Conflicts hidden/obscured. (Borrowed from Terrence Yang‘s Disclaimer on Quora)