The changing face of investing

There is a very overused investment mantra that goes like this,

“High risk, high returns. Low risk low returns.”

If we were to stick firmly to this statement then we should always invest in the asset class with the higher risk as it would bring us a higher return. Investors fail to see that there is a missing word in the statement and that word is “potential”. Let us rephrase the statement and now it goes like this,

“High risk, high potential returns. Low risk low potential returns.”

The word potential thus inserts an element of doubt that the expected return would turn out to be less desirable and not as predicted or hoped for. In the real world, many investors have been burnt because they had hoped for above average profits. A recent incident to note would be the China stock market crash which effectively halved the stock market indices and bankrupted many investors who were heavily leveraged to purchase equities. They had focused on the potential gains and not on the potential losses. It is the potential to make a windfall that drives investors to make decisions that are irrational and potentially financially suicidal. What then would the flip side of investing in risky assets be? Government bonds are certainly safe. However looking at the poor take up rate of the recently launched Singapore Savings Bonds would point to the fact that Singaporeans are not warming to the idea of getting an annual yield of between 2 to 3 percent. This goes to show that investors in Singapore have grown a little hungrier for higher returns on their investments. Let us analyze how the face of investing in Singapore has changed since the last fifty years.

1) It is getting harder to get supernatural profits above what the market deems as a normal rate of return.

The normal rate of return is something that is hard for us to place a number on. As a rule of thumb I personally would assume that investors would find anything with a yield of higher than 5% as attractive and would rarely expect a return of investment to yield them in multiples of the original invested amount. Long gone are the days when a property owner could purchase a property for a mere SGD$10,000 and the price would appreciate to more than a million Singapore dollars. Such scenarios are not unheard of. There are indeed many instances whereby a landed property owner is sitting on a plot of land which has a value of more than a million dollars and yet the price which they paid for would be in the region of SGD$10,000.  This would be a rate of return of more than 10,000 times the original invested amount. To put this into perspective, if prices continued to appreciate at the same rate of return, a $1,000,000 HDB flat at The Pinnacle would cost $10,000,000,000 in 50 years time.

2) Investors are getting more savvy and are usually well educated.

In the past, investing was usually only done by those who had the financial might to do so. In the earlier years of Singapore’s development, not many people were interested in where they could put their savings to yield a higher rate of return than the meager savings interest rate that their deposits were earning in their savings account. Investing in the stock market was rather unheard of and the Asian Financial Crisis of 1997 did little to invite new entrants to the market. Property ownership was a primary concern of most people rather than owning multiple properties to yield good rental returns. However, the investment climate has changed and we have a more educated population today who are savvy enough to understand that they need to understand about investing to grow their wealth. In today’s market, banks are trying to outdo each other, financial innovation is very much alive and investors attend multiple investment courses.

3) There are well defined laws to protect most investors.

Access to legal representation has been more prevalent due to the fact that the general public is more affluent. On top of this the internet has led to a proliferation of legal information. Lawyers are often viewed as the “go to” people when one needs legal advice. It is very common for the common man on the street to use the phrase “let me check with my lawyer” whenever he is unsure about any matter. The flip side is that if every document and situation were to be scrutinized by a lawyer, the cost of resolving issues would increase. The Singapore regulators have also put in place checks and balances to ensure a conducive climate for investing and although scams whereby investors have lost large sums of money still exist from time to time, these are generally few and far between. The authorities have also come down hard on mis-selling and misrepresentation of financial products. The penalties are severe and the culprits are usually reported widely in the media to prevent a repeat of such behaviour.

These factors have collectively contributed to a rise in the number of investors in the market. Imagine a large number of people sniffing out investment opportunities at any one given time. This is the reason why great investment opportunities in the stock market and real estate market are difficult to come by. This places a lot of pressure on the already low yields that are coming out from these markets. This is why in today’s market, we deem a yield of more than 4-5% as something that is deemed healthy and attractive.

This is where investing in alternate asset classes can take investors back to earlier days when yields were less depressed. To get supernatural profits once again, investors have to look at something that is less common and thus less competition from other investors. One form of investing that can be done is through crowdfunding. The concept is not new and it is essentially pooling monies from different investors and putting them together so that collectively the group has a stronger bargaining power in the market. To put it loosely, investing in unit trust is similar to crowdfunding. Thus the market is perhaps not too unfamiliar with such a concept.

Let us thus borrow an example of a certain investor by the name of Warren Buffet. Mr Buffet is widely regarded as the greatest investor of all time and his returns have over time have far exceeded the performance of the S&P or the Dow Jones Industrial Index. One compelling reason that investors fail to realize is that people like Warren Buffet are dealing on different terms as compared to the common retail investor. Mr Buffet, due to his financial might, can acquire companies at terms that are unavailable to the retail investor. For example, during the peak of the financial crisis in 2008, his company, Berkshire Hathaway, was called on to make an investment in Goldman Sachs. Mr Buffet negotiated for extremely favourable terms. He bought a $5 billion stake in Goldman Sachs that paid an annual dividend of 10%. Berkshire also received warrants to buy an additional $5 billion worth of Goldman Sachs stock within a 5-year window at a price of $115 per share. Such terms were hugely favourable and only available to people with great wealth and thus bargaining power like Warren Buffet and Berkshire Hathaway.

Let us then summarize

1) Buffet and Berkshire Hathaway is rich

2) Because he and Berkshire is rich he has a good bargaining chip

3) Because he has a good bargaining chip he can get terms that normal retail investors cannot get

4) Buffet is also very well trained and experienced to source out great deals and manages money well

Individually we cannot compete with people like Warren and perhaps collectively as well. However we can learn from his example and this is why crowdfunding to invest can work.

1) Crowdfunding makes the collective group richer

2) Because the collective group is richer, the group has a better bargaining chip

3) Because of this bargaining chip, the group can get terms that normal retail investors cannot get

4) All we need is a well trained and experienced team to source out great deals and make sure that there are checks and balances in managing the groups’ monies

However, all crowdfunding platforms are not created equal. This is why personally I am not in favour of investors buying into units trusts that invest into equities that are readily available to retail investors. Crowdfunding platforms are commonly referred to as funds as well and namely I prefer to invest in real estate funds which have a collective competitive advantage. Due to the nature of real estate in the fact that it takes great wealth to own just one unit of real estate, it takes great wealth to accumulate real estate in huge numbers to diversify one’s real estate portfolio. This is the difference when it comes to investing in a real estate fund. The collective wealth of everyone allows the fund manager to negotiate favourable terms when the fund makes a purchase on the asset. This is the attractiveness of a property fund or namely a property crowdfunding platform. There are just a few things to take note.

1) Crowdfunding has risks involved and these risks must be managed

Due to the complex nature of binding an agreement when it comes to pooling a large group of monies together, there will be a need to hire professionals with expertise to ensure that the monies are well managed. The fund manager should be credible and preferably regulated by the Monetary Association of Singapore. The contracts should be drafted in English and should be vetted properly by legal professionals before investors start placing monies into the fund.

2) The platform should be one that has a competitive advantage which the investor cannot get if he was not in the platform

Crowdfunding should provide the investor with a certain form of advantage. For example if an investor were to buy a property for $500,000 but instead he could own 10% of a fund which owns 10 units of a similar property for just $400,000 then there is an advantage for him to place his monies with this certain fund. Collectively crowdfunded platforms can purchase properties in bulk and thus obtain large discounts off the prices of these properties. Alternatively, crowdfunded platforms can use their strong financial might to purchase larger properties, for example large buildings. Larger buildings usually have a lower per square foot price as compared to small individual units. This in turn translates to a higher potential rental yield than if an investor were to buy a small unit by himself. Furthermore, collectively the fund can obtain better terms with financial institutions with regards to financing the bulk purchases. This would perhaps translate into better loan to value and lower interest rates and ultimately healthier return on equity for investors.

3) The cost to run the platform should not be so high as to erode away the profits because of the competitive advantage

There is cost associated in setting up the platform and maintaining it. The legal fees to set up the fund and the management and marketing fees to market the fund will cost some money. Hypothetically speaking if the fund has a 40% margin due to the fact that the monies are pooled together and pay 15% away to setting up the fund and to the people managing it then there would still remain a healthy profit margin of 25%. However, if the cost of setting up and managing the fund were to be higher than the potential margin of the platform, then it would not make sense for investors to invest in this certain fund.

4) Crowdfunding platforms help to defray potential costs when investing individually

In the local Singapore market, there are costs associated with buying multiple properties like the additional buyer’s stamp duty. These costs do not need to be paid by investors when investing in a property fund. Moreover investing in a property fund is akin to adding to one’s property portfolio without adding to the physical number of properties which one has. In today’s climate whereby those who have multiple properties have to pay more taxes on their investment properties, investing in a property fund can be a good alternative to saving the hassle and monies associated with owning a physical property on your own.

5) Real estate crowdfunding can be a rather low risk investment with high potential returns

Due to the fact that a crowdfunded platform can purchase units at below market price, there is thus more potential for an upswing in the value of the asset acquired. The crowdfunded platform can also enter the market at the development stage and reap the returns of developing the property. Due to ability of the platform to get in at a low entry price point, the risk of acquiring an asset that would be difficult to make a healthy profit would be much lower than if an individual investor bought an individual unit from a developer.

Just to summarize, the fact that there is an ever changing and competitive investment climate one has to look at alternative forms of investment to better the returns out there in the market. I personally believe that the mantra of coming together to invest collectively will be around for a very long time.
Yours Sincerely,

Daryl Lum