Sunday, 30 September 2012

Picking The Right Horse For A Small Cap Fund

For the longest time, I’ve worried about the performance of LM SEA Special Sits in my portfolio. Finally, I’ve found the time to compare the alternative I’ve been mulling around my head as a replacement for the fund – Aberdeen Asian Smaller Cos.

As at 30 Sep, here’s what my portfolio looks like:

Despite making a bit of money in the recent upsurge (thanks QE3!), I’m still facing a loss on my China exposure, and my US exposure, which proxies for developed equity exposure, because…well…I couldn’t find a compelling global equity fund (although DWS Top Div might be an interesting proposition).

In any case, this article tracks my thoughts on whether I should change my exposure to Legg Mason QA SEA Special Sits to Aberdeen Asian Small Cos. I find writing this down gives me a point of reference for the future, so I can have a clearer idea of what in the world I was thinking when I made the decision, or to leave a digital trail to prove my sometimes questionable frontal lobe activity.

In any case I wrote about these two funds approximately a year ago, when I compared both of them against one Mr Madoff, who had delivered 10% annualized returns consistently until the day his Ponzi scheme collapsed. The funds since then have posted far more modest rates of return because the start and end-points have changed. And the Madoffs, post Ponzi collapse, have also faced a drastic change in lifestyle.

For sake of comparison, I’ve used the MSCI Asia Pacific ex-Japan index (MXAPJ:IND) as a common benchmark. The two official benchmarks are MSCI Far East (MXFE), and MSCI APJ Small Caps (MXAPJSC), which are close enough for the MSCI Asia Pacific ex-Japan index to provide a fair proxy.

Granted, neither fund uses this benchmark, but the other two benchmarks used track fairly closely, so I think it’s a reasonably (but certainly not perfect) useful benchmark.

In any case, enough yap flapping. This is how the two funds stack up:

From the above, it’s quite clear both sit on opposite sides of the spectrum – Legg Mason will do badly in down markets (like 2011) and will do well in up markets, often stunningly so, with an average outperformance of 40pp in strong bull markets. Meanwhile, Aberdeen, true to its reputation for being conservative stock pickers, does well in bear markets, but underperforms in bull markets.

So should I switch? If I do, it’ll be because I believe there’s more pain to come, and that Asian equity markets will get hammered, and from a valuations standpoint, it’s kind of middle of the road, so there’s little guidance there. In other words, markets seem rather wishy washy, and to quote the reformed broker, “Tops are a process, Bottoms are an event and Middles are a motherfucker.

Sunday, 23 September 2012

Of Fakery And Funds

What happens when a fraud spotter goes up against hedge fund star?

You get Carson Block of Muddy Waters bear versus John Paulson of Paulson & Co bull, waged on the theatre of Sino-Forest which,  reported in a BBC article, defiantly announced intentions to sue Muddy Waters, which sounds rather spiteful on the part of Sino-Forest, especially since the title of the same article is, “Sino-Forest Files For Bankruptcy Protection”.

Since then, Muddy Waters has been made out by the media to be something of a financial vigilante, publishing articles on fraudulent accounting by Chinese companies. 

Questionable accounting is not new for Chinese companies, and most investment professionals will readily agree that accounting standards in China are somewhat flexible at best. Taking a quote from Charles Li, Chief Executive Officer of Hong Kong Exchanges & Clearing Ltd, some Chinese companies listed in the US via reverse takeovers “wouldn’t have seen the light of day here.

So what has all this have to do with the Singapore mutual fund scene? The story comes in 3 parts: Muddy Waters vs Focus Media, Bronte Capital, and Eastspring Investments.

Arc 1: Muddy Waters vs Focus Media
November 2011, Muddy Waters released a report, initiating coverage on Focus Media, which it claimed fraudulently overstated the number of LCD screens it owns. You can read the full report, “Muddy Water Initiating Coverage on FMCN – Strong Sell” here. On the day of the report’s release, 21 November 2011, the impact on Focus Media was significant.
image credit: Yahoo! Finance (note added)
Since then, Focus Media has recovered back to 23.76 as at 22 Sep 2012. But that’s just arc 1.

Arc 2: Bronte Capital
Bronte Capital is the name of the blog, written by one John Hempton, CIO (Chief Investment Officer) at Bronte Capital Management

Since August, he’s written approximately 16 articles around Focus Media, which is probably enough to fill a short novel of more than 10,000 words. Granted, it’ll be 10,000 words of financial storytelling which is probably a niche market at best. Still, John writes simply, and more importantly, candidly, which is fairly rare in this industry.

Bronte Capital articles re Focus Media
Source: Bronte Capital,, last accessed 23 Sep 2012
There’s a lot of good reading in the posts, and John goes through, in some detail, the reasons why one might suspect Focus Media of over optimistic at best and outright deceptive at worst. But where my interest gets piqued is in reference to one Ashish Goyal, CIO Asian equities with Eastspring Investments.
John writes, “Finally it is being written for Ashish Goyal from Prudential Investments who is Focus Media's largest shareholder and was quoted in the WSJ stating he wanted more than $30 for his shares. [Someone please forward this to Mr Goyal. He seems a reasonable man.]”

Given I’ve had the opportunity to interview Ashish, he strikes me as a pretty conservative and experienced sort of money manager.

Looking through Eastspring’s annual reports also reveals Ashish doesn’t have any direct positions in the funds under his management, although Eastspring is listed as one of the top holders of shares.
Enter Eastspring Invesments
Turns out Focus Media helpfully compiles a list of top shareholders:
Image credit: Focus media,, last accessed 23 Dep 2012
And right up there with 4.4% ownership is Eastspring Investments Singapore.

Based on Morningstar’s data, Ashish manages Eastspring Investments - Asian Equity Income A Inc. Meanwhile, the two funds listed by Focus media include Eastspring Investments – China Equity Fund, managed by one Nicholas Koh, and Eastspring Investments Unit Trust – Dragon Peacock whose manager is not listed in Morningstar’s database.

Not content with this, looking through Eastspring Investments’ annual reports (as at 30 June 2012) turns up several more funds that hold Focus Media, including the following table.
Eastspring Investments Funds with holdings of Focus Media
Fund name
% of Net Assets
Valued at
Asia Pacific Equity Fund
Andrew Cormie
Asian Equity Fund
Kannan Venkataramani
China Equity Fund
Nicholas Koh
Dragon Peacock Fund
Dr Rao
Greater China Equity Fund
Nicholas Koh
Hong Kong Equity Fund
Nicholas Koh
source: Eastspring Investments Unaudited Semi-Annual Report as at 30 June 2012

manager source:

As at 30 June 2012, Focus Media isn’t found in any funds directly managed by Ashish. I’m guessing the reason why he was quoted as saying he wanted $30 for Focus Media is because he is acting as a spokesperson for Eastspring Investments, speaking on behalf of the firm and quoting a price that was quoted to him.

There’s no telling who is right on this particular call. Muddy Waters has a reputation for shorting fraudsters, and the amount of material put out by Bronte Capital seems to support some sort of accounting irregularities is going on. On the other hand, Eastspring Investments is a solid fund house in its own right– some of its funds are highly rated by various rating agencies.

The difficulty is essentially identifying deception – if a company sets out to intentionally defraud investors, enrich its inner circle of family members, business partners or friends – then there are two ways to establish the truth, either via a confession, or by building a store of facts inconsistent with the story. And humans in general are monumentally bad at spotting liars. 

Friday, 14 September 2012

On Being Wrong: DWS China Equity

This is not an easy post to write.

Not that I’m going to divulge some dark secret tucked away in the dank, deep corner of my alleged heart; it’s somewhat worse, because on this semi personal blog where I spew mind farts, I have to make the uncomfortable act of proving myself wrong – an act as pleasurable as substituting toilet paper for  durian husks or using the ancient Japanese version of toilet paper. No wonder they came up with the ‘no paper’ toilet; ancestral memories sure last long.

What brought me here?
After reading NN Taleb’s Fooled By Randomness, (which I heartily recommend to any investor with a literary mind) I found myself faced with the growing realization that past performance is next to useless when it comes to predicting future performance.

Nearly every study done to determine if past performance can determine which fund will outperform finds little to no connection – the top performers of one year will be the bottom performers of the next year. No one outperforms all the time.

So far, this is known to me. I’ve always worked on the understanding that the best are right only 6 out of 10 times. The full quote comes from Peter Lynch, which reads,

"In this business, if you're good, you're right six times out of 10. You're never going to be right nine times out of 10." – Peter Lynch, One Up On Wall Street (?)

Where this becomes a problem is at the level of fund selection, and you have two funds, A and B, one of which has better 5-year annualized returns than the other. Typically, I would say that 5-year annualized outperformance means the fund has good long-term outperformance. 

That’s what I’ve been told, that’s what I’ve been repeating. And, that’s where I’ve been doing it all wrong.

The problem is 5-years is still one single period – a long period nonetheless, but it’s just one, single period. I think the technical term for what this results in is small sample bias (or hasty generalization, or unrepresentative population, depending on how pedantic you want to be). Looking at various periods, say 1, 3 and 5 year returns, is equivalent to looking at 40 rich people in Singapore, and concluding that all people in Singapore are rich. Using three observations to arrive at a conclusion that applies to a fund’s general performance is likely to have more than a few blind spots.

So what now?
The answer, I think, will be to consider all possible periods, within a defined time. I’m referring to rolling periods, which accomplishes two things 1) increases sample size, which also 2) reduces end point bias.

And this brings me to the crux of the conundrum – a flawed recommendation.

Some time ago, I wrote about the DWS China Equity Fund, saying “The fund tends to outperform in up and down markets”. Ah youthful folly. Markets have since then pummeled the fund’s performance into mediocrity at best, and depressed ennui at worst. 

Looking at its factsheet shows the fund returned (over 12 months as at 31 Jul 2012) -14.99% versus the benchmark MSCI China return of -10.96%, which is underperformance of -4.03pp.

Sure the China market has had a tough run, but actual performance is hardly consistent with my earlier statement. Clearly, in a toss-up between my conclusion and the market, market wins. The market is always right – even when it’s wrong. So the next thing to do is fix my conclusion.

Fixing Leaky Conclusions
Substituting rolling performances for discrete performances should at least help solve the issue of small samples. The fund’s performance will be compared against the benchmark. In this case, the benchmark is the Hang Seng. The Hang Seng isn’t entirely the best benchmark to use, but for this trial run, it’ll do.

Performance is based on all rolling 12-month performances from end-2005 to end-May 2012 (around 6 years). I want to separate market performance into 5 categories:

-          Strong bull: greater than average positive market return
-          Weak bull: within average positive market return
-          Trendless: Zero
-          Weak bear: within average negative market return
-          Strong bear: greater than average negative market return

Over the period, the average positive market return is 22.6%, while the average negative market return is -18.47%. Across these categories, I’ll examine how the fund performs. The purpose of this is to help me arrive at a conclusion about how well the fund’s strategy/fund manager/team holds up across various market conditions. 

That conclusion will be based on two key questions: 1) How often does the fund manager beat the benchmark’s return and 2) by how much does the fund manager beat the benchmark return?

Two charts answer the question: 

Any conclusions based on past performance are made on the assumption that you’ll see roughly similar performances going forward. 

Conclusion: Recent strong bear underperformance is definitely higher than average (-4.03pp, as stated way above), but not so much that it’s a huge difference from the average of -2.93pp which is good in the sense that performance numbers suggest the manager isn’t drifting too far from the established method. 

Historically, this fund shines (and how) in a bull market for this fund to shine, but in a bear market, this fund will probably drift down to the middle of the pack, and possibly even further. Which it has.

For now at least, it feels like this is a better position to take. Sure it’s not the kind of certainty that people tend to believe strongly in,  but I feel more comfortable with this position than I did in my previous one. For now.