High note 5 - Know what you have invested

Recently, the hottest news in the press is about High Note 5 saga. As a result of bankruptcy of Lehman Brothers, the investors suddenly discover that the investment they thought was safe is actually not. Worse still, some lost their life long saving.

It is not exactly clear on the terms and condition of the product. But in a nut shell, these are the facts gathered on the web:
- The structured product is linked to a basket of banks and when the credit event trigger, investor is likely to lose money.
- If everything is fine, we get the 5% interest from this product.
- It is supposed to be a credit default swap(CDS) in disguise

A structured product is a combination of financial instrument to be sold as a package. They can package a lot of different instrument together and sell to investors. The key selling point is enhanced yield. This is the result of the income that some underlying instrument generates.

CDS is a form of insurance. The seller act as the insurance company, gives the buyer protection in return of a premium. If nothing happen on the protected asset, seller get to keep the premium.

The auntie uncle who bought the product was sold on the promise of 5% interest return. It is quite a high return consider the bank deposit interest rate in Singapore. Maybe the relationship manager did explain about the product features. However, how do you expect the man on street to understand CDS and credit event? Furthermore, the reference entities are all big names, which unlikely to fail.

The sales person often highlight more on upside rather than downside. Beside this, getting the customer to understand the product is also a tough job. More than often, if you cannot convice them, confuse them. Many investor claims that they are not aware that they could lose all the investment amount. It is either a form of ignorance or the risk is being down played. From another perspective, it is like putting all money into one basket. This basket was thought to be very safe, but is actually not.

Not an easy problem to solve.
- Bank has to refrain selling complicated product to people who cannot appreciate the product risk.
- There has to be constant education program for people to recognise that high risk high return.

When the sales person trying to sell you product, ask yourself, do you really understand the product. What I always believe is if it is too good to be truth, then it most probably is.

The current US financial system problem

Yesterday I read a news article from WSJ, it gives a great explanation on what happened recently in US and the seriousness of the problem. A good read: http://online.wsj.com/article/SB122169431617549947.html

We seems to have gone from over leveraging to aggressive de-leveraging. The new FED measure actually aims at clean up all the toxic asset and let bank back to conventional lending-borrowing. Then, the credit crisis that choke the economy could be over.

Super panic about AIG

Look at the queue outside the AIA tower, we know that many of them are in panic mode regarding their insurance policy and the cash value of their insurance. Many took the redeem first, think later approach when fear and panic set in. It is kind of human instinct to do that, just like stock market.

Of course, people who hold on to the AIA policy would be afraid, including me. But, we have to analyse the situation. AIA as a company itself, under the MAS regulation, should have operate within the guideline. From their statement, they have adequate fund to cover all the policy holder.

On a separate note, AIG is such an american icon, the FED won't allow a sudden collapse. This is hard to articulate, but it is a logical step for them. So, I am not that worried with my AIA policy.

This is human behaviour which could explain the current market rout. Now, it is driven by news and not really by valuation. We are just at one extreme end of the market cycle. But buying in now, means you have to endure the volatility and your nature fear. Unless you have mind of steel, you better stay sideline for now. Give it another 3 months and see how is the situation. Market is not likely to just recover suddenly, expecting more "collapse" maybe. Sit tight...

Lehman and Merrill Lynch in trouble

The shocking news today is Lehman to file for bankruptcy and Merrill Lynch to be bought over by Bank of America. The wall street fear has became a reality and financial market keep tumbling. It looks like the credit crisis would deepen before it gets any better. Before the light at the end of tunnel is sighted, stock market is going to fall whenever there is bad news. It looks like a knee jerk reaction now. The Asia market is reacting to US market news more violently than US itself.

At this juncture, the market direction is unclear. We are at the unique situation now, which Greenspan said is a serious crisis. As we don't know how worse it could go, holding back any buying decision seems to be the only wise thing to do now. Cheap could become cheaper, remember. There are still things you can do. Brush up your investment skill by reading more books and perform some reflection on your investment decision. This would aid the future adventure.

There are many short sellers out there who short on any bad news that come out from the US. I met an ex Uni friend who does regular trading. He mainly doing shorting now. That could explain the increased volatility we have witnessed. The problem with trading is not a few times of continuous win. It is the challenge of doing it right most of the time. One big bet that goes wrong could bring you back to ground.

I am also taking my time to go through my existing holding to eliminate the weak performer and search for future strong performer. The good part about bear market is you can take your own sweet time to do research and you are buying on cheap, if not, super cheap.

Trapped in bear trend

The US financial sector is in serious turmoil, because of the excess built up over the years and the creative bankers. When sub prime issue first came into picture, nobody expects this bad, or at least not the man on street. Now, it seems like the sub prime is only the trigger of the bear. We are not economist or expert(even the expert not always right), nobody could predict when it would end, earning downgrade is the in thing now.

The stock is now on fire sales, which is rare over past few years. The valuation is so depressed now, in my view, the risk of holding equity for a period of 3 to 5 years is significantly reduced. In fact, you have a high chance to make big profit (of course, not immediately). Financial market is a reflection of human instinct which tends to overshoot on both side - top and bottom. People still expect the equity price to fall, therefore there is no interest in stock. Hence, the forever falling price. Maybe 3 years later, when you look back, you would regret that you missed such a great opportunity to accumulate stock.

However, not all the stocks are equal, at this tough time, it is a real test to separate the boys and men. Look at the company competitive position, market leadership and future plan, to give a clear idea of whether this is a gem being indiscriminately sold down. Buy on cheap and wait.

The equity price won't stay at this depressed level forever, someday when the confidence return, the rebound could be significant. Although economy goes through up and down cycle, in the long run, economy is set to grow. Because the human population keep growing. Good company would earn more profit and stock price would follow.

Bargain is everywhere now. Of course, everybody is waiting to buy it even cheaper when it fall further. I am a long term China consumer bull, the consumer stock looks very attractive now. Even the blue chips are also selling at reasonable price!