Using Endowment Plans As An Investment Tool [Chills 28 with InvestQuest]

Welcome to another Chills with TFC session. In this series, we bring on interesting, relevant people to help us learn better from various perspectives. Life is not always about learning from people that you already agree with. Perspectives shape a rounder thinker so in our pursuit of the life we love while managing our finances well. Our guests for today is a couple that have built an interesting financial blog commenting on multi-asset investing with the fun retro gaming graphics.

They both started their career in the financial space analyzing REITs, stocks and advising high net worth clients. So let’s welcome Peter and Deborah from InvestQuest. For the sake of reference, this episode was recorded on 29th April 2021. 

You know bond is not something that a lot of retail guys will talk about right? 

Deborah: So what do you mean? It’s a really small minority. 

Reggie: Yeah. It’s like non-existent, right? So can you give us a little bit of an idea, where do you see the bond market moving? The general idea is that “oh interest rates so low. How to make money from this space?”

Peter: Actually your question is a two-part question. Bonds are actually impacted by two factors. One is obviously the interest rate environment. But the second factor when you’re investing in corporate bonds is also what’s known as a credit spread, the compensation you’re getting for investing into a risky asset.

A riskless asset will be something like a Singapore government bond or a US government bond whereas a corporate bond, when you invest in a government linked company like SIA or Keppel, you’re still taking an element of a corporate default risk. So maybe just to cover the first aspect: the interest rate environment. How is it looking like at the moment? So for the interest rate, most people just think of it as one number. It’s actually a spectrum. There is short term interest rates. There’s also what is more known as longer term interest rates or long-term yields which can be proxied by stuff like a US 10 year treasury bond, your 30 year treasury bonds.

So maybe I’ll cover a bit on the short term interest rate first. I’ll let the longer term yields be explained by Deborah a bit. So for the short term interest rate, actually governments or central banks have a large say in influencing these short term rates. So for example, if we look to the US, the central bank will be the Federal Reserve and they are the ones who sets what the Fed (Federal) funds rate is. Currently, the Fed set it to 0 to 0.25% obviously to stimulate the economy. If you look at what are the expectations of when the next rate hike is gonna be, the base case is in 2024 onwards, which means that in the next few years, likely we’re not going to see short-term interest rates going much higher because even in the local market, we are quite influenced by rates set in by other major economies like US.

Reggie: Especially the US. 

Peter: Yah, so when it comes to our bank deposit rates, fixed deposit rates here, I think we will still be hovering at where it’s currently at in the next one to two years.

Reggie: Same for mortgage.

Peter: Same…

Reggie: As an extension of SIBOR (Singapore Interbank Offered Rate)? 

Peter: Yeah, so same as for mortgages.

Reggie: Okay, so you’re saying that short-term interest rates are very affected by what the government does, how they set, because they’re essentially the referee of the market. They say it’s like that, and every other bond will kinda reflect… referenced to that kind of interest rates. But they don’t actually have direct control in the markets.

Peter: Yeah. So again, also it depends on country. So for example, in Singapore, actually MAS doesn’t really set the interest rates. It’s quite freely moving but in certain countries like the US, actually they do have a say like what the Fed funds rate is. So I think it really depends which country we’re looking at, but given that Singapore is such an open kind of market economy, we are very impacted by what’s going on around the world.

Reggie: Okay. Yeah, and what about long-term? 

Deborah: So for long-term interest rates, they’re expected to increase steadily as the global economy recovers. Now, when you’re analyzing long-term interest rates, people tend to look at factors like expectations, economic growth, inflation, so on and so forth. Looking at these factors, they’re all pointing towards higher long-term interest rates moving forward. So now summarizing what Peter has mentioned and I have just talked about, analysts are expecting what is known as a steepening in the yield curve, where short-term interest rates remain anchored and long-term interest rates increase. Yep. 

Reggie: So then as retail investors, how do we capitalize in such a situation? 

Peter: For retail investors, actually it’s very tough now because for us, a lot of our emergency savings tends to be invested in obviously, your traditional bank savings accounts and more recently, there’s also been the emergence of a lot of robo-advisors that have this cash… what they call cash management accounts, or even a lot of the insurance, you know, even SingTel Dash, Gigantiq, Singlife account. These are all insurance savings accounts that have recently come onto the scene to give local retail investors a slightly higher yield than what they’re getting from bank accounts.

But with the overall market interest… the short term rates being so low, we’ve also been seeing across traditional banks and even on these cash management accounts, yields just generally have been quite suppressed. In fact, a lot of banks in the last 1-2 years, you will know they have been cutting your interest rates. Three years ago, it was very easy for us to get 2-3% return or interest rate on our savings account as long as we did some criteria, like salary crediting, paying a few bills, GIRO-ing a few bills or using a credit card from the bank. But today, if you want to get a 1% interest rate, it’s really going to be very tough.

Reggie: There’s a lot of asterisk in the 1% interest rate, right? 

Peter: Even for the robo-advisors, we’ve seen a lot of them revising down their projected return rates to reflect this more realistic kind of return expectation moving forward. 

Reggie: Can you help us understand a little bit, like how do they derive these kinds of returns? 

Peter: For robo-advisor cash management accounts, a lot of them are invested in a mix of money market kind of instruments. It’s short term debt instruments. Some of them have short term bonds also. All of these are very heavily impacted by what the short term yields are. 

Reggie: Yeah, essentially they’re correlated with the short term rates. And then for some of these insurance companies, is it all the same? Are they all using money market funds? 

Peter: For the insurance companies, we can’t really see what they’re invested in. But just from my point of view, if you’re a insurance company, and you need to raise capital, you have a few methods you can do so. One, you can of course get money from these policy owners and give them that 1+%, or you could go to the capital markets, issue a bond and pay 3-4%.

So for them right now, this could be potentially a very cheap way to get financing. Insurance companies are not the same as banks because banks have a deposit base. They can just go out to the depositers and they get this very cheap form of funding. So the best alternative for insurance companies to issue these kind of savings… short term savings accounts.

Reggie: It’s a strategy to acquire more capital for them. Okay… so it’s definitely affected, relative to the market. Because they don’t want to be overpricing themselves also. So in general, I think all of them will be performing similar. Whatever option you take, they’re all pegging against each other, right? It’s not really a way that they make a lot of money, but I think it’s a lot more about acquisition. 

Peter: Yeah. Client acquisition. 

Reggie: Client acquisition… just kinda keep you within the ecosystem. You become comfortable with us and then upsell other things. In general, that’s kinda what it is.

Peter: Yeah. So like for Singlife, a lot of us actually went to (open) a Singlife account last year because they offered quite a good return rate. If I’m not mistaken, towards the end part of last year, they launched a new product, things like investment linked plan, they call it Grow. Obviously, if you already have a Singlife account, it’s an easy way to just cross sell. 

Reggie: Yes. That’s the world turning into the whole digital finance… where you see a lot of that social media tech elements that have been used in a lot of other kind of consumption platforms, even in the digital finance world. So I think listeners need to be a little bit more aware of these kind of things. Companies are doing these things that used to be okay because Lazada do it and you’re just buying things, it’s fine. But now, financial companies are using a lot of these kinds of tech strategies and I think people need to be very aware of. 

Deborah: Another thing that I think is worth mentioning is that when there tends to be a significant difference between… let’s say the projected returns for a cash management account offered by the different robo-advisors, there may be differences in the underlying funds and the risks that they pose. It might be a marginal difference, but that is what can result in that higher return that they offer to you. 

Reggie: Yeah. So definitely you need to understand what is the underlying instrument that they use. Don’t just… “Oh 1.5%, you put 1.5%” like that. You want to know what’s going on, right? 

Deborah: Yeah. 

Reggie: But in a general environment where interest rates are so low, how can I make more money?

Peter: So it’s a spectrum.

Reggie: Because it’s going to stay like that for a while, right? Based on what we are projecting, 2024. 

Peter: Correct. So it’s a spectrum. I think for many people here, I think gold based investing has become an “in” thing. Gold based investing. I guess for your emergency funds, advisors will say, keep 6 to 9 to 12 months of your expenses as an emergency fund, and this can be deployed into stuff that’s a bit more liquid, very low risk, which is what we’ve been talking about. Could be your traditional bank savings account, your insurance savings accounts, and even some of the robo-advisor accounts. Even though those aren’t actually… the cash management accounts actually are not principal protected. It is still subjected to market volatility, marked to market.

Reggie: Would you guys consider government bonds as risk-free, in that sense? 

Peter: The credit risk is very low, but it’s still subject to interest rate risk. For example, let’s talk about 10 year US treasury bonds. Most people think of it as a risk-free asset, but from September, October last year, 10 year treasury yields were at 0.6%. Now it’s at 1.6%. So that 1% move in interest in yields would have actually caused your 10 year treasury bond to decline by 5-6%. Actually for the first quarter of this year, the US 10 year treasury bond market actually experienced the worst performance since 1980 even though you consider it a risk free asset. 

Reggie: Be cognizant about these things, right? 

Peter: Yes. Correct. 

Reggie: Okay. So then if I don’t want to participate in the markets, I just want legit risk-free. What are some ways that you can participate in?

Peter: If you have a slightly longer time horizon, there will be some insurance companies that will market endowment policies, right? So I think one insurer that recently came to market was Great Eastern. They launched a 3 year endowment policy that offers a 1.55% per annum.

Reggie: 3 years? Very short.

Peter: Yeah. So 1.55% return per annum and fully guaranteed as long as you hold it to maturity. If you actually went to get a 3 year fixed deposit from a bank, the returns is only about 0.6%.

So you’re still seeing these.. I wouldn’t call 1.55% very high, but given that it is a guaranteed on maturity for cash that you don’t really need in the short term, and yet you want some guarantee and you want a slightly high yield then endowment plans potentially could make sense.

Reggie: Especially when they are shorter and shorter these days. 

Peter: Yeah. So for endowment policies, they’re marketed across a wide range. It could be as short as one year. Even for myself, my family, we have bought into one-year policies last year. We wanted to park cash in a yielding account that is more than 1%. So we actually had some policies, just one year. But obviously for endowment policies, they can stretch to as long as 40 to 50 years. And it’s really to cater to different goals that investors might have. 

Reggie: That was actually the standards in the past. Endowment plans were very long, at least what is very prevalent in the market, right? Retail amongst the aunties, uncles. When they think about endowment plans, 30 years. Nobody think of endowment plans as a 3 year, 1 year kind of thing.

Deborah: It used to be a very popular investment option and it still is for a lot of people. Currently, I think there are 2.3 million endowment policies that have been incepted in Singapore.

Reggie: Nice. Just to give everyone a bit of context. In the past, endowment plans were paying out a lot more interest. 

Deborah: Yes, but then to be fair, they were paying out a lot more interest, but the interest rate was also much higher. 

Reggie: Yeah. So back then during the high days of 12% interest rates… but they were paying at that kind of price. But it’s still packed with the market in essence, packed to the interest rates market based on how it moves. But I think for a lot of people, when you hear your older generation say endowment 很好 (very good), don’t flame them because at that point in time, they were getting that kind of rates and it’s locked in, the rates are locked in. So over the extended period of time, they were getting that kind of very good rates relative to the market. 

But these days, things are different. But I know you guys are doing the whole traded endowment thing and you’re not alone in the market right now. I think Phillip Capital, they also do that, and a few other companies, they also do that. Not sponsored, must say. Not sponsored. How does that then play out in this thing?

Peter: Actually the funny thing is the reason we got into the space is because we actually wanted to buy these traded endowments as investors first. It was about three years ago. I was looking at the inventory for some of the brokers. They were offering about… let’s say 4 to 4.5% per annum projected returns for the investor for policies that were maturing in let’s say 7 to 8 years time. So this is not the policies that are 30 years away. 7 to 8 years is still… I’ll say relatively medium term and to get a 4 to 4.5% projected return to me was pretty decent because 3 years ago, the interest environment was really very low, right? If you are buying into high yield bonds at a time, probably that’s the kind of expected return you’re getting for yourself. 

Reggie: The risk premium that you’re paying is high. 

Peter: Higher, cause you could be buying a high yield bond with a 5% yield to maturity, but there’s also an element of default risk. Because high yield bonds on average, I think default rate is something like 3%+ per annum. So you are taking the kind of default risk. Personally I was looking at something that.. I was looking for my parents. Cause my dad’s already 72 this year. I wanted.. 

Reggie: You don’t want anything exciting for an uncle at 72 right? Confirm, confirm.

Peter: We wanted something more conservative and 3 years ago we were already in a bull market for nine years, for stock market. So I was not very confident in also putting a lump sum investment into a stock market, at least not for my parents’ retirement money. Yeah. And that’s how we actually came across the space. Yeah. 

Reggie: How is it different then, endowment versus traded endowment?

Peter: So the interesting thing about traded endowments is we would have bought it from the original policy owner. If the original policy owner wants to surrender his policy prior to maturity, most people would think that you only have one option, which is to surrender the policy back to the insurance company.

But typically when you do that, the surrender value they get from the insurance company tends to be very poor. Especially in the first few years, let’s say if it’s less than halfway through the policy, they could have lost almost half of whatever they invested.

Deborah: Yeah but it’s not necessarily because of any greed on the part of the insurance company. It just so happens that the insurance company has to pay for distribution costs, or your agents. 

Reggie: “Distribution costs”, very sterile ah. 

Deborah: That’s a very nice way to put it. And so because of that, that’s already a sunk cost of them and they cannot give you back that amount. 

Peter: And actually the insurance company doesn’t earn from the policy owner, surrendering the policy. So if the insurance company gives a poor value to the policy owner who surrender, actually the other existing policy owners in that plan actually benefit in a way. So the intention of giving a poor surrender value is to actually to discourage you cause you’re supposed to hold it to maturity and to protect that other policy owners who are currently invested in the same plan.

Reggie: To give everybody a bit more context. Insurance companies and insurance agencies and the retail guys are three different parties. Because a lot of people will say it’s an insurance company.

But I think because we are talking about exactly the issue of the product, we need to be clear that the insurance company are the ones that issue the products. Your interaction, as a retail individual, tend to be with the agency. They are the ones that sell you. So that’s the sunk cost for the distributor.

Okay. So then in that sense, how does traded work then? Because they don’t want to encourage you, then how does it work? 

Peter: Yeah. So for the person who’s thinking of surrendering his policy prior to maturity, he actually has a second option that many people don’t really know about, which is he can actually sell this policy in the secondary market.

So in Singapore, there are… I’d say maybe about five or high single digit players who can actually purchase such (policies). They do this as a business and they offer the policy owner a value that’s above the surrender value. Only then will it make sense for the person to then sell to these brokers ourselves included. So when we first started buying these policies, we obviously had a dual mandate… [laughter] 

Deborah: Don’t worry, he reads finance news every day, so after a while it just slips in.

Reggie: Go ahead. Go ahead. 

Peter: So for ourselves, obviously we were buying these policies as an investment for ourselves right? We had to hit a minimum threshold to make sense for ourselves. But at the same time, our intention is not to low ball the policy owner surrendering the policy, right? Typically the person who’s surrendering it is really not in a very good situation himself, therefore surrendering it.

We wanted to also bring in a social aspect to buying these policies. So far based on what we have purchased, I think we’ve managed to offer about 25% above the surrender value. 

Deborah: 25%. Yeah.

Peter: So I think that is something that I think is well above market at the moment, compared to some of the other brokers.

Deborah: Some of the other brokers will.. They say on their websites that they offer a 5% to 10% above the surrender value just for context. Yup. 

Reggie: So their margins are much thicker in that sense. 

Deborah: Much thicker. because they know that let’s say the policy owner only knows about them as the only broker in the market or thinks of them as the only broker in the market, then they just have the chance to low ball.

Even if you give 2% higher than the surrender value theoretically, you’re still better than them going to the insurer. So they might as well just offer you as low as they can.

Peter: Actually it also depends on the company’s competitive edge, what they’re trying to achieve. So there are some companies which will try to have an edge in terms of marketing. So they’ll go on the radio, post on newspapers or have a larger distribution network, but that also will feed into higher costs for the firm. So for ourselves.. So I wouldn’t say that they’re offering a lower fee because they are getting a bigger profit, but I think it just depends on what business model we are trying to work with.

At least for ourselves, we try to work with a model that is to keep costs as low as possible so that we can give a good price to the policy owner but subsequently.. You know when we buy over, we will also be looking for investors that we can sell it to.

Reggie: Can you paint me a little bit of a picture? What does a typical endowment plan today looks like?

Let’s say there’s a 30 year endowment plan. What is the kind of expected returns that I can get and versus a traded endowment that I buy from somebody halfway? How does it look like?

Peter: So maybe I won’t use a 30 year example because for traded endowments, typically you have bought it halfway into the life, right? So if it was a 30 year endowment, it would have now probably be left with 15 years. So maybe you use the example of a 15 year new endowment. 

If you went to an insurance company today to buy a 15 year endowment plan, the expected return for the policy owner likely would be around 3% per annum, right? When you look at the… what you’d call a benefit illustration that’s provided by the insurance company, a lot of them will show a base case of a 4.75% investment return. This rate is actually legislated by MAS. It’s a relatively realistic rate of what the insurance company is able to achieve in terms of investment returns, but the policy owner doesn’t get a 4.75% return because you need to minus off, like you mentioned just now, the disturbution costs, the cost of managing all these investments. 

So for the policy owner, typically he gets about 3% per annum. For a traded endowment, which is what many people refer to as a secondhand endowment policy, typically what we see in the market right now is that for 15 year policy left to maturity, you can probably get about 4.5% per annum return. It is significantly more. You think from 3% to 4.5% is a 1.5% difference, but actually it’s 50% more. 

Reggie: So essentially what I’m hearing is I am picking up something that someone already pay halfway already. They subscribed to this endowment plan and they’ve already paid halfway through, something happened, they decided to drop it. So then when I buy it, I have to pay up all the sums that they’ve already paid in some ways to the individual that’s trying to sell it. And in this process, they get back a little bit more. But then I kind of continue paying that premium. Is that kinda how it is?

Peter: The reason I mentioned that the yield can be a bit higher for secondhand endowment is actually because for the investor, he might actually not pay what the original person paid. 

Reggie: Yeah, for sure. Because we’re basing off surrender value, right? 

Peter: Yeah. Basing off surrender value. So if you are paying less than what a guy has paid, that’s why you’re getting a higher yield. That could be one reason. The second reason is because the policy has already… let’s say it has been running for 15 years, right? The policy has had time to accumulate some sort of investment returns and declared annual bonus for these 15 years. This could be the other element that is driving the higher returns for the secondhand policy relative to a first-hand policy.

Reggie: Okay it sounds very pretty right. Everything sounds pretty. But what are some of the risk factors then? 

Deborah: In terms of some of the risk factors… let me first cover the risks, which are similar to the risks of a new incepted endowment policy. The first is if the underlying participating fund that the insurer holds performs badly, then there’s a chance that they may not be able to pay out the maturity value that they had projected.

So this is a risk for a new policy, and it’s also a risk that traded endowment policies will face. 

Reggie: It’s the same, right? 

Deborah: It’s the same. 

Reggie: But then how do I evaluate the underlying funding?

Deborah: You generally will not have a.. 

Reggie: You don’t know, right? It’s just a.. Endowment, essentially you’re trusting the insurer and then they will take the money and then they have their own investment mandate, that they will do on their own. You don’t actually get to evaluate that. 

Peter: You get to see the historical performance of these participating funds across insurance companies. You know, for the astute investor, some of them might want to avoid certain insurance companies because they might feel that historically the performance of their funds hasn’t met up to the 4.75% projection if you look at the last 10 years, for example. So there are ways to differentiate across the insurers marginally. And the second way is also to look at the asset location in the participating fund. Some insurers, if the stock market did really well this year and you see that their asset allocation was more tilted towards equities, potentially you know that this year, this insurance company is probably going to do a bit better.

Reggie: But are you going to be getting more, if they perform better? 

Peter: Yeah, so actually the projected maturity value can be revised upwards as well. So I’ve seen such instances, but I will say that over the longer term, like the last 10 years it is more likely that they revise down just because the interest rate environment has been going a bit lower.

Reggie: Okay, okay. That’s cool, that’s cool. 

Peter: So for traded endowment policies, they’ll be sold by a second hand policy broker.

Reggie: Which you guys are one of them in that sense. 

Peter: Yes. So when you’re buying from a secondhand policy broker, we are not financial advisors. I’m not going to be able to tell you “oh based on your financial goals, you should be buying this and this” or you should be… “this is how you should be looking at your portfolio holistically”.

Reggie: Essentially selling a product. 

Peter: Correct. We’re just a broker. So you would have to think about what your financial goals are and how you’re going to achieve them on your personal basis and potentially you would’ve already asked your financial consultant. You shouldn’t rely on the broker to give you advice like this. A second risk that you will face when you’re dealing with a secondhand broker, is that for traded endowment policies, they are not an asset class that’s regulated by MAS. 

Reggie, Peter & Deborah: [laughter] 

Deborah: The space is still too small, so it’s unlikely the MAS will come in..

Reggie: I know in the UK, they already have structured products around traded endowments. 

Peter: So in fact, in the UK, in Australia, there are mutual funds that actually hold traded endowments. And of course I mentioned they’re yielding 4 to 4.5%. So these mutual funds are able to distribute this 4 to 4.5% as income, so it’s almost like an income fund.

Reggie: Yeah, exactly. 

Peter: And it’s diversified across insurers, diversified across… [indiscernible] 

Reggie: Risk managed in that sense.. 

Peter: Like just now what I mentioned is that this space is not currently regulated by MAS. So if you do purchase a policy, it’s a bit like going to Carousell and buying an item there.

Reggie: I don’t know how I feel about that leh. It’s like “oh, you’re buying a financial product. It’s like going Carousell like that.”

Peter: So that is a risk. That is a risk that the investors have to take. So if anything goes wrong, you shouldn’t be approaching MAS for it because it’s not a regulated space by MAS. What you can do is you can go to the Consumer Protection Act instead. 

Reggie: Look for CASE (Consumer Association of Singapore). Everything look for CASE.  

Deborah: Which makes sense. That makes it even more important to do your due diligence on the different brokers and see which one gives you more disclosures etc.

Reggie: So fundamentally you are reliant on the trust with the broker.

Deborah: Trust with the broker as well as yourself. You have to educate yourself on what the product is, right? Because if you don’t know enough about the product, it will be difficult to know what people are not telling you.

Peter: One way to get around this issue also is to conduct the transaction, which is what we always do. We always conduct the transaction at the insurer’s insurance company’s office, so that when we go through the terms of the policy, It will not be me telling you what the policy terms are. I would’ve already told you earlier, but you can then clarify and confirm everything with an independent customer service staff at the insurance company. I think that way, the risk for you will then be much more mitigated. 

Reggie: Okay, at least you get clarity of what does this particular policy covers and all the interesting things inside a structured product, essentially. Okay that’s cool. So are you seeing more and more people pick up on this idea and how does it then sit into people’s broader financial plan? Because exactly like what you point out in the UK, it’s becoming like an income fund.

Although I know you cannot give exactly like “how to do it”, but it’s just more where do you think people can adopt traded endowment, as part of their portfolio?

Peter: So for me, the traded endowments space would cater for people who have specific goals in certain parts of their lives.

Reggie: That’s the beauty about endowments, right? Cause it’s essentially I give you money and then you give me a fixed return. It’s like a trust-based thing, limited market movements in that sense. 

Peter: For some goals that you have, it may not be compromisable for you. For example, you just gave birth to a child and you know that 18 years’ time, he’s going to college. So you know that his college education, the fees..

Reggie: I.. scared for your kid.

Peter: It’s not compromisable, right? 

Reggie: “That’s not compromisable ah. You MUST go to university.” 

Peter: You need to have a guaranteed amount of money at that point of time. Obviously a lot of people they know 18 years quite far away, then they invest in the stock market. Just in the.. If you are very suay (unlucky) and during that year, there’s a downturn and you’re down 30%, do you really want to be liquidating your portfolio at that point of time to pay for a school fee? Probably that might not be the best option.

For endowment policy or for the traded endowment policy, there are two elements to it, right? There’s a guaranteed component and maturity, and there’s a non guaranteed component. So at the very least if we are buying a policy that’s 18 years away, you can see that minimally if the insurance company declares zero bonus every year for the next 18 years, the maturity bonus is zero, you know that it’s still this guaranteed amount, which is obviously the most unlikely of scenarios, but at least you’re secure that that’s enough for your child to go to college. 

Deborah: So it makes sense for those who are already considering endowment plans but they want a yield pickup, right? So then they see that, how come traded endowment policies are offering better yields and potentially for shorter amounts of time? Yeah. That is what makes it attractive to investors. 

Peter: Of course, there’s two downside risks that the investors have to take note of. Because when there’s the good part there’s always the bad part also, right? 

Reggie: People always like to talk about the good part, yes.

Peter: The bad part is, if you are buying it for the insurance component, the traded endowment doesn’t give the investor insurance coverage on his life. The insurance coverage is still on the original life assured. So theoretically, if the original life assured, let’s say if he passes on, the investor actually can claim the death benefit from the policy. Typically, that will be a favourable kind of thing for the new investor. But because they won’t be in contact with each other, this will not likely be the case. You don’t know the person, you won’t be getting his death certificate. Typically, we just ignore the insurance component. This is something that the investor will not likely be getting.

A second downside is that for policy, we know that you’re supposed to hold till maturity, it’s an illiquid vehicle. So when you think about… let’s say the 2007 – 2008 crisis, there were quite a number of mutual funds that were holding these traded endowment policies at that time. And during that period of time, obviously a lot of people get very panicky, right? Everybody starts to sell the mutual funds at the same time, but if the underlying asset is illiquid, it just doesn’t, it just doesn’t work.

Reggie: It’s very hard to drop it off.

Peter: So this should be something that you are saving up up till a particular date, not something that you’re are looking to sell again in the next one, two years. 

Reggie: Essentially the boring vehicle, not the exciting thing. You probably should have a plan for it in that sense. Essentially, people would explore a tool like that on their search for income to try to achieve a certain goal and have that kind of consistency, and make a better yield, and what is the current interests market up there. But what are some other tools that people can explore in your view?

Deborah: I think it’s possible to explore CPF top-ups, if you top up to your Medisave account.

Reggie: The 1M65 ($1 million by 65 years old) movement. 

Deborah: Yeah, the 1M65 ($1 million by 65 years old) movement. If you top up to either your Medisave account or your Special Account, you can earn 4% per annum. The downside to that is that obviously if you’re a young person, you cannot withdraw the money anytime you want. Because it’s a long-term savings account. But yeah, I think that’s one major way that people can look to increase the yield on their cash. Peter, can you think of other ways? 

Peter: Yeah. Obviously Singapore has been encouraging people to top up their CPF. There are obviously certain schemes where you can get tax deductions on your top ups as well? So let’s say if now you’re 45 years old already and you know that you can withdraw your… some part of your CPF when you’re 55 and you are currently having a marginal tax rate of let’s say 10%. So if you are getting a 10% tax deduction on your contribution to the CPF, and you spread it over this ten-year period, actually you’re getting almost 1% extra yield a year, so actually you’re not getting 4%. You’re actually potentially getting like almost a 5% type of return in a sense so I think that is something to me is I think it’s very… every Singaporean has CPF so it’s something that I personally do every year, topping up my SA (Special Account), topping up my Medisave account. 

Reggie: Okay I think that’s cool, but I think for everybody they need to be very aware, right? This is a one-way track. Nothing’s going to come out until you reach that retirement age.

Deborah: I think our most popular article today is our CPF article, right? Five ways to optimize your CPF. 

Reggie: And those kind of articles tend to be very popular. In the sense of like: 5 ways to do something, 10 things you need to blah blah blah, very listicle. As long as you’re comprehensive, you get shared very well.

So that’s definitely part of it but of course, I think people have to also be aware, of like minimum sum, all those kinds of things, CPF life.. It’s all part of a thing. Because it’s the whole vehicle. Don’t just look at it from one component, right? Yeah. So you’ve got to look at the whole vehicle before you put money in. Generally, that’s my take. But what about entering, like what we talk about, high yield bonds or like Chinese bonds, those are like… increasingly there’s a lot of discussion over there, so yeah. What is your take?

Peter: So if you look at the high yield bond space, let’s just say you just take a look at US high yield bonds. Typically you’ll see them yielding about 4.5%, maybe 5% yield to maturity. And for many investors, that may sound like quite high attractive level for them.

But one thing that they need to note is they have to factor in the expected default losses for high yield… especially for high yield bonds. So for example, the average default rate for US high yield bonds has been bought 3+% across the market, across the economic cycle. And for the defaulted high yield bond, the recovery value is typically about 20 to 30 cents on the dollar.

So what that means is that you should be factoring in around 2%, maybe 2.5% of expected credit losses every year from whatever high yield bond portfolio they that you have. So if you’re getting a 4.5% yield to maturity, if you minus off 2% or 2.5% in expected default losses, actually your expected return is only going to be about 2%, 2.5%, which is in my view, not very exciting. The high yield bond market now is definitely not cheap. 

I think there are certain parts of the high yield market which offers a relatively better… relative value? So for example, if you look at the Asian, US dollar high yield space, the credit spreads over here are slightly wider. If you look at the yield to maturity of the Asian high yield bonds, you can still get about 7% yield to maturity.

And historically, actually even though people think that Asia is like emerging markets, but default rates are quite similar to that as a US high yield bonds. So if you’re getting 7% and let’s say you minus about 3% of expected default losses a year, you are at least getting this expected 4% return.

So in that case, it’s still not too bad and if you look at the high yield bond market within Asia, it still hasn’t recovered back to pre COVID levels. Whereas for the US, it recovered really quickly and really way past the pre COVID levels.

Reggie: Can you give us a little bit more clarity in a sense of like default rates? So what I’m hearing is if the whole fund has like $100 million and it yields at about 4%, but the whole 100 million dollars will generally lose about 3% of its capital every year, essentially because of defaults. Is that what I’m hearing?

Peter: That’s what I’m saying.  

Reggie: You factored that 3% loss into the whole portfolio which you are a fractional owner of the whole portfolio. 

Peter: Correct, correct. 

Reggie: So then nett, maybe 2%, 3%. Yeah. But if you go to the Asian market, which is currently still giving it about 6-7%, you factor that 2-3% loss, you still have about 4% or 5%.

Peter: You have a bit more buffer in that sense. 

Reggie: A bit more buffer. Okay.

Peter: And actually, if you have the view that credit spreads start to tighten, you actually might get additional capital appreciation as well on top of the existing yield that you’re getting on the Asian high yield bonds.

Reggie: Because the bond market have not recovered yet.

Peter: Has not fully recovered yet.

Reggie: Has not fully recovered yet, so there’s still that squeeze that can come in… wow we’re going very technical, huh?

Peter: Just now earlier in the podcast where we were talking about two factors that drive fixed income markets. One was interest rates, one was on credit spreads. So this, we’re talking about the second element, the credit spreads. Yeah. 

Reggie: Paint me a little bit of a clearer picture. How does that work? 

Peter: Okay. So for example… just to explain what a credit spread. So for example, if let’s say you have a US treasury bond and currently the yield is 1% per annum, that’s the risk-free rate. If you are buying to a corporate bond in the US, and let’s say it’s yielding 3% per annum, the credit spread is this excess compensation you’re getting for buying and taking this credit risk. So the credit spread will be 2% in that case. So when we look at the US high yield bond market over the last 15 years, the average credit spread level has been about 5.5%, and currently it’s about 3.6%. 

So the current level is quite near the lows of the last 15 years. So you’re not really getting in at a great time. You’re not getting the bang for your buck, but at the same time, of course, we are also on a economy recovery. So everyone has priced this in.

Reggie: Yeah. Okay. So then in Asia, people have not priced it in, so that’s the beauty of the spread. 

Peter: Yeah. So in Asia, if we look at the last 10 years, the average credit spread for high yield bonds here has also been around 5% to 5.5%. But now the credit spreads in Asia is 6.3%. So it hasn’t even recovered back to the historical average yet.

Reggie: Is there a reason why? I know correlation is not causation. We’re not trying to predict like why exactly, but just kinda give us some colour so that our listeners can get a clearer understanding. 

Peter: So I can think of two big reasons. One is last year, obviously in the US, they supported the bond market by purchasing not only government securities, but they also supported it by buying investment grade bonds and even high yield bonds. These were all bought by the Federal Reserve.

Reggie: Yeah. They were just buying.

Peter: Just buying. So obviously this also drives higher the price of high yield bonds over there and drives down the credit spreads. But in Asia, we don’t really have this equivalent, what we call artificial buyer in the market. And the second reason why the Asian market hasn’t recovered fully is because a large part of the Asian high yield bond market is actually comprised of China property bonds. And you know, recently in the space, the Chinese government’s trying to clam down on debt levels over there. They have a warning about a potential bubble in the Chinese market and this will result in these Chinese property developers finding a tougher time to refinance their bonds. And if that’s the case, there’ll also be a slightly higher risk of default. Because if you can’t refinance your bond, how are you going to start repaying the bonds that you previously borrowed on?

Reggie: So then they will pay you more to get that premium so that they can continue to kick the can down and it keep rolling, keep rolling. Okay, so then are there tools very specific to the Chinese bond market?

Peter: So for bonds, obviously you can buy it directly, but because most bonds are traded in denominations of USD200,000 or SGD250,000, these are meant more for high net worth investors in Singapore. 

Reggie: For the [indiscernible], for all of us.

Peter: Even if you are a high net worth investor, you have like let’s say, 10 million… 

Reggie: You don’t want to concentrate. 

Peter: You shouldn’t be putting 2.5% of your cash in a single bond insurer also anyway. So the alternative is you can go through more diversified vehicles. So one way is ETFs, and the other way is mutual funds. For ETFs, within the local market listed on SGX, there are ETFs that trade China government bonds. So that’s… to me much safer. That’s yielding about 3% per annum, which I think is still pretty decent.

Reggie: Do you consider that risk-free? Because the government is the issuer, correct? 

Peter: So you have to look at the credit rating of the government also. So for the China’s government rating, it’s rated “A” by S&P, which is the same as Japan. So I would say it’s fairly safe. To be rated the same as Japan is fairly safe, but the thing that people need to note about investing in Chinese government bonds, especially the government bond ETF that is listed on SGX is that underlying bonds are traded in RMB (Ren Min Bi; Chinese Yuan). So you’re also taking this additional currency risk even though when we trade it on SGX it’s traded in Singapore Dollars. Yeah, but it could be a double edged sword because if you are bullish about the RMB in the next 2-3 years, that could be a driver of returns for you also as it continues to appreciate. 

Reggie: Yes. So that’s the thing with a lot of products out there, right? You think it’s a certain thing, like you’re trading on SGX, you’re using the Singapore dollar, but underlying tools is China still trades in RMB so there’s multi tiers. I think people need to be a lot more aware of these kind of things. 

Peter: There’s also a Asian high yield bond ETF that’s traded on SGX. I think it’s issued by BlackRock or iShares. But the problem with it is that it’s not very liquid. So if it’s not very liquid, what happens is that there tends to be a slightly wider bid ask spread. You know when you trade stocks, sometimes if you’re buying a stock at $10, you see that the bid price is $10, the ask price is $10.01. But if there is not enough liquidity, instead of $10.01, it becomes $10.10 maybe. So that is a cost that many people might not factor in.

Reggie: So one last question for both of you, I think we’ve explored all these different tools, from like traded endowment to high yield bonds to cash management apps, even CPF… wow CPF 都跑出来 [also come out]. Everything is part of this thing. So I just want to give our audience a little hypothetical, right? So if someone is just starting out, making money and a little bit into their career, about 30 years old, 35, have some sort of money sitting around, how will you then… but they don’t want to be too exciting in the stock market because I think a lot of people generally, I think there are a lot of people that are risk averse. Of course, we can talk about the historical yield and all those kinds of things like why you should have some sort of portfolio in equity. But let’s say they don’t want to be in equity, how do you think they should structure their portfolio then amidst all these different tools? 

Peter: I think it always goes back to your goal based investing, right? So your 6 to 12 months kind of savings, I’ll put it… the stuff that you actually need for day-to-day expenses definitely has to be in your traditional bank account. Anything else… 

Reggie: In the future, it can be a digital bank account. 

Peter: Yeah. Then maybe for the additional, let’s say three months of savings in your traditional bank account, additional six months could be in something that’s a bit higher yielding, right? It could be your cash management accounts by the robo-advisors or the insurance savings accounts, right? For your next chunk of your cash that is for your medium term goals, stuff that you need in the next two to three years, it also needs to be in a relatively conservative type of investment. Then you can consider maybe potentially endowment plans, right? Because that comes with a guranteed component to it already, and you can customize it to meet your goal that’s happening in 3 to 4 years time.

For anything that’s more than that, if you want something that’s a bit less risky, I still think stocks are a good long-term investment, anything that’s more than like 10 years. You know, I’m just citing an example, right? If you had a 10 year investment period and you invested at any time between the year 2000 and 2020, you have gotten at least a 3% or higher return per annum. If you had looked at the MSCI All Country World Index. Obviously this is backward looking, right? You can’t really forsee the future. 

Deborah: I’ll just really broadly diversify ETFs. Buy one more tilted towards the developed world and then one for emerging markets. If it’s really well diversified and you’re willing to hold that for a long period of time, I think investing in stocks is actually not as crazy or as exciting as a lot of people make it out to be. It generally is more difficult to look at bonds because they tend to be a little bit more difficult for the person on the street to understand. 

Peter: And I think for the bond market now… like just now you mentioned, the short term rates are low already, but at the same time, you still expect the long-term yields to rise. So if you’re entering the market at this point of time, you are actually faced with a very big dilemma. On top of that, just how you mentioned that credit spreads are already very tight. So if you invested in a bond that’s maturing in 10 years time, you lose out from interest rates potentially rising, you lose out from potentially credit spreads widening also, and that’ll both impact the value of your corporate bond.

Reggie: Fair. So either way, I think all in all the idea is don’t be afraid of the stock market, right? Don’t be afraid of stock market. Be broadly diversified. And if you have some other things that you need, other goals that you can explore, all these other tools that we have discussed today. 

Deborah: If they do select single stocks, I think that’s where more of the risks can come from. So if like: Oh if I put 20% of my portfolio in Tesla, super exciting, then that’s where you might get a significant dent in your portfolio if one stock crashes. 

Reggie: Single stock risk concentration. 

Peter: But I think.. I still think that bonds are okay, but it really depends on the investor. Like recently, Singapore Astrea bond that was issued. Strong subscription and it’s a 10 year bond, but there’s a mandatory call at the five-year mark. And if you know you’re not gonna use this money for the next 5 to 10 years, then yeah, you are able to weather out this mark to market and volatility of the market in the next two to three years, potentially.

Reggie: Yes. I fully understand what you’re saying. Actually, the bonds… historical bond returns are actually very healthy, also. Not 10 years, but you extend a hundred years, actually it performs very well also. But the problem is like what you two have pointed out, it’s not easy to understand right, there are more moving parts in this thing. We can always have another conversation some time down the road! Thank you. Thanks for coming on. I appreciate it.

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Okay, I have last three questions that we ask every single guest. Okay. The first one is what is a core life principle that you hold close to? 

Deborah: Okay, so I’ll take that one. It’s not a principle per se. But we like to think about this concept called “IKIGAI”. That’s I K I G A I. I see you nodding. Do you know about it? 

Reggie: I just finished reading Wabi-sabi.

Deborah: For the listeners, basically, this is a Japanese concept that outlines four objectives that people can have in life: doing what you love, doing what you’re good at, doing what the world needs, and very importantly, doing what you can be paid for. So whatever career you end up choosing, I think Peter and I have observed that there generally just tends to be an imbalance between the 4.

Maybe you don’t feel that you’re earning enough or maybe you don’t feel that there’s enough meaning in your work or whatnot. And there are two ways to compensate for it. So the first way is to work within the framework, right? You could, let’s say, if you don’t think your job is super meaningful, you can do a pro bono on the side. Or let’s say, you think your 9 to 5 job is not earning you enough cash, for some reason, you can try to earn money elsewhere. But the second way is to work outside of the framework and that is to… usually it means setting up your own business or your own enterprise. 

And so for Peter and I, that’s what we have done with respect to InvestQuest and with Endowment Exchange. As Peter mentioned earlier for Endowment Exchange, it was really important for us to have that social element to it. And for InvestQuest, we really wanted the flexibility to explore what we were interested in intellectually, having that freedom. 

Reggie: Nice! Okay. Next question.  What is a personal finance advice that you feel needs to be further propagated? 

Peter: Something that’s more applicable to young adults, which is… your personal net worth is actually comprised of two aspects. One aspect is your financial assets, right? So your cash, your stocks, your bonds. The second aspect, which is commonly overlooked is your human capital. In financial terms, that’s actually your present value of your future earnings.

And as a young person, bulk of your personal net worth is actually in your human capital. So you need to get this right first. And that would mean even growing up in secondary school, you should already be getting some sort of career advice. And with that, hopefully you can then build up the correct educational background, the correct skill sets, and also pursue something that eventually, you are also personally interested in. Hopefully that also works out in your favor. Which brings you a good career, rewards you financially and also something you find purposeful at the end of the day. 

Reggie: I’m getting very concerned for your future kid. Secondary school must career advice already.

Deborah: Actually I think Peter will be the more chill one. I think I will be a tiger parent. Yeah. 

Reggie: We’ll see we’ll see. So last question. What is your current life focus? What are you focusing on, giving additional focus on? 

Peter: So I will quote what Jack Ma said before. He said that when you’re in your 20s to 30s, you should find a good boss, work for a good company and learn to do things in the correct way.

When you are between 30 to 40 years old, you have more room to explore, even if you fail, it’s still okay at that point of time. When you are 40 to 50 years old, that’s when you should be focusing on doing what you do best. It’s a bit more risky at that point to start to explore new ventures, really.

And when you are 50 to 60 years old, take the time to then nurture the new generation and provide these mentorship opportunities. And once you’re past 60, you need to spend more time your grandchildren. So currently for Deborah and myself.. 

Deborah: You don’t need to spend time with your children right in any of those decades. 

Peter: So where we fit in would be the 30 to 40 year old age range, which means that we have time to explore new ventures, which is what we are doing with the InvestQuest, what we are doing with Endowment Exchange. But at the same time, we also think that nurturing ourselves and developing ourselves both on a personal basis and on a professional basis, I think that’s something that we have been trying to do.

I think we have been a bit late to the game with regards to let’s say, crypto assets, with regards to computer programming. But I think it’s better late than never. So I think that’s what we aim to learn next. 

Reggie: Nice. Thank you. Thanks for coming on. Appreciate it. 

Peter: You’re welcome.

Deborah: Thank you so much for having us.