Public Newsletter 4Q 2013

Keeping Your Capital Safe
Europe Stoxx 50
ASX 200
Nikkei 225
Public Newsletter for the period ended
31 December 2013
Market Commentary
Portfolio Review
Currency Mismatch
The top performing developed market was in
Asia. Japan’s Nikkei 225 soared as investors
bet on Prime Minister Shinzo Abe’s economic
stimulus to arrest deflation and spur recovery.
In emerging Asian markets, full-year returns
were less uniformly positive:
1. Foreword
Fellow Investors,
Welcome to the Lighthouse
newsletter for December 2013.
Shanghai Composite
Hang Seng Index
India Nifty Index
Jakarta Composite
Thailand SET
Philippines PSEi
Malaysia KLCI
Singapore STI
The Lighthouse Fund is finally up and
running! This is the first newsletter concerning
the Fund.
For the benefit of new investors, all of the
Fund’s holdings will be briefly discussed.
Subsequent newsletters will only discuss new
investments, divestments and significant
corporate events.
Shanghai was weighed down by fears of a
slowdown, while in Thailand, widespread
demonstrations (both for and against the
government) spooked foreign investors. These
two markets will likely prove interesting to
those willing to look beyond first impressions.
Your manager wishes everyone a Happy
Lunar New Year.
Your manager is becoming interested in
Thailand, but given the political complexities,
patience is essential. Jeffrey Race, a political
analyst based in Thailand for the last 45 years,
points out that the problem is not abuse of
power per se by the Shinawatra clan, but its
sheer extent and duration1. This is complicated
by the fact that some of Thaksin’s policies did
actually improve the lot of the rural poor, so
they voted for him at the ballot box. In Mr
Race’s view, any long-lasting solution must
address both the Shinawatras’ departure and
rural development.
This newsletter follows the same format as
previous issues. The special topic for this issue
is Currency Mismatch.
2. Market Commentary
Major stock markets ended 2013 with solid
gains amidst economic uncertainty.
Cost cuts and increased consumer spending
boosted corporate profits in the US. At the
same time, European markets were heavily
oversold after several consecutive years of bad
news, which sparked a rebound. Developed
markets generally did well, as shown below.
US S&P 500
Lighthouse Advisors Private Limited
Reg. No. 201212773E
10 Anson Road, #38-03 Unit A
International Plaza, Singapore 079903
As we enter the Year of the Wood Horse,
stock markets worldwide have again been
spooked by the US Federal Reserve’s tapering
of its bond-buying activities. Coupled with
History shows way out of Thai conflict, Asia Times,
13 Jan 2014.
Updated 24 February 2014
Keeping Your Capital Safe
data showing that China’s official Purchasing
Managers Index dropped to a 6-month low in
January, stock markets have begun selling off
20 securities made up 55% of the Fund’s
holdings, with the balance in cash. NAV
values are tabled in Annex I.
To protect the interest of clients, detailed
discussion is confined to the client-only
version of this newsletter. Client newsletters
are embargoed for one year, after which they
are made available online.
As is often the case, momentum chasers have
abandoned yesterday’s favorite, and last year’s
top dog Japan is currently the worstperforming developed market, with the Nikkei
225 down 13% year-to-date as of market close
on 6 February. Emerging markets have also
suffered outflows, along with currency
declines, most obviously seen in India,
Indonesia, South Africa, Turkey and Brazil,
who have been unflatteringly dubbed the
“Fragile Five” on account of shared woes such
as fiscal and current account deficits, falling
growth rates, above-target inflation and
current-year political uncertainty.
4. Currency Mismatch
A currency mismatch occurs when an entity’s
assets and liabilities are in different currencies.
As a result, the entity’s ability to remain
solvent becomes at least partly a function of
exchange rates.
During periods of economic stability,
exchange rates fluctuate only mildly, leading
some entities to take on currency risk with the
expectation that either the status quo will
continue indefinitely, or that they will be able
to unwind the mismatch before the exchange
rates move against them. Unfortunately, too
many people, companies and even entire
countries have found that exiting such
mismatches in time is easier said than done.
Your manager considers such fears with
regards to Asia to be overblown, and is buying
selectively as prices decline. If prices continue
to fall, value will become more widespread,
making investing easier, but fundraising
harder. This is the strange irony of the fund
management business, where one can raise
money and make money – but not usually both
at the same time. In any case, your manager
has invested more money into the Fund.
“How did you go bankrupt?” Bill asked.
“Two ways,” Mike said. “Gradually and then
The next newsletter will be published for the
quarter ended 31 March 2014.
– Ernest Hemingway, The Sun Also Rises
Benjamin Koh
Investment Manager
Lighthouse Advisors
7 February 2014
bankruptcy to “friends,” and when there is a
currency crisis the government of the day
often blames external parties. Unfortunately,
in many cases, deeper analysis shows the
damage to be self-inflicted: it is merely the
delayed payback for poor policies set in
motion years earlier.
3. Portfolio Review
As at 31 December 2013, the Net Asset Value
(NAV) of the Fund was USD 102.93. Net of
all fees, the year-to-date return since inception
in September 2013 was +2.9%.
Government overspending is common enough;
few countries regularly run a budget surplus.
If the increase in accumulated deficit is small
enough that economic growth outstrips it, this
is not an issue. This is akin to someone
borrowing a little more each year, but next
Asia stocks fall on China PMI; Nikkei closes at 2-1/2
month low, CNBC, 3 Feb 2014.
Updated 24 February 2014
Keeping Your Capital Safe
year he earns more than the increase in
borrowings, so that his debt-to-income ratio
remains stable or even declines.
wheels fell off the bus, so to speak. With
foreign currency liabilities suddenly doubling
in local currency terms, companies and
consumers alike were forced to deleverage,
compounding the economic slowdown.
Given a low enough debt position at the start,
people (and countries) can increase their debtto-income (debt-to-GDP) ratio for some time
without trouble. But eventually the
accumulated debt becomes too expensive to
service, and “sudden” bankruptcy (currency
collapse) occurs. This is common sense, and is
in fact the basis of the first-generation
currency crisis model as described by Nobel
laureate Paul Krugman in 19793.
One might imagine that only emerging
markets, with their supposedly unsophisticated
financial infrastructure, would resort to such
currency mismatches and suffer accordingly
from the fallout.
In Australia, banks have long had an apparent
currency mismatch. A strong economy growth
and accompanying demand for credit left the
banks short of funds, so starting in the late
1970s they turned to wholesale funding from
abroad4. Today, about 1/3 of Australian bank
loans is still funded by foreign currency loans.
But the vast majority of such foreign loans are
hedged back into Australian dollars, so in
effect there is very little net currency
Excessive foreign currency borrowings, which
cannot be repaid via the domestic printing
press, helped spark the 1997 Asian financial
crisis. In the ensuing fallout, the Thai baht and
Philippine peso lost more than half of their
pre-crisis value against the benchmark US
dollar. Indonesia was the hardest-hit: at one
point the rupiah fell 80% against the dollar.
Seen through this lens, the implication for
investors is simple: avoid countries with
heavy foreign currency borrowings.
This prudence is another reason to consider
Australia a developed or “mature” economy.
This is not by itself a bad thing: “mature” may
mean “not growing rapidly” but it also means
“not behaving recklessly” – a rather important
point that any investor interested in preserving
his capital should appreciate.
When it was realized that the first generation
model did not fully describe all the known
currency crises, it was developed further into a
second- and now third-generation model.
As bottom-up investors in the securities issued
by companies, it is mainly the third-generation
model that interests us. For corporate balance
sheets, the simplest thing to do is to simply
avoid companies that are heavily indebted.
Indeed, several of the companies in which the
Fund is currently invested have the kind of
balance sheet we describe with a single
sentence: “The Group is debt-free, and cash on
hand exceeds all liabilities”.
In the third-generation model, private-sector
balance sheets are in focus, specifically
companies with foreign currency debt. These
were in abundance in Thailand and Indonesia
prior to 1997. They were essentially betting
that their respective governments could
continue to keep the exchange rate stable.
They borrowed cheaply in US dollars to make
high-yielding investments in baht or rupiah –
or even simply left it in the bank to earn high
rates of interest.
The next simplest thing to do is to avoid
companies with a currency mismatch – yes,
despite the lessons of the 1997 Asian crisis,
there remain companies who insist on having a
These interest rates were of course subsidized
by the government, but eventually the sums
involved became unserviceable, and the
A Model of Balance-of-Payments Crises, Paul
Krugman, Journal of Money, Credit and Banking,
Vol 11 No. 3 (Aug 1979) p311-325.
Trends in the Funding and Lending Behaviour of
Australian Banks, Stewart, Robertson and Heath,
Reserve Bank of Australia, December 2013.
Updated 24 February 2014
Keeping Your Capital Safe
currency mismatch. The two such entities to
be discussed here are Religare Healthcare
Trust (“RHT”) and Lippo Malls Indonesia
Retail Trust (“LMIR”).
financial engineering: the sponsor, Fortis
Healthcare, has waived its share of
distributions until 31 March 2014. Without the
waiver, the yield would be 7.8%. Factor in the
not-inconsiderable currency risk – the Indian
rupee fell over 40% against the Singapore
dollar in the last 5 years, a compounded
annual loss of over 8% per year – and it is
clear that an investor in RHT today is taking
on meaningful risk, with no certainty of a
satisfactory return – or indeed any return at all.
Both trusts are listed on the Singapore
Exchange and trade in Singapore dollars. They
also pay cash distributions in Singapore
dollars. RHT operates in India, while LMIR
operates in Indonesia.
Both receive rents in local currency i.e. Indian
rupees and Indonesian rupiah respectively. Yet
both have taken out Singapore dollar loans
against their assets abroad. The reason, of
course, is that it is cheaper to borrow
Singapore dollars than Indian rupees or
Indonesian rupiah. Obviously, this introduces
currency risk into the company’s operations.
But there may be another issue lurking
beneath the mismatch.
As for LMIR, its latest results for the quarter
ended 30 September 2013 show distributable
income of SGD 19m, or SGD 76m annualized,
against investment property of SGD 1.5bn.
Interest payments total SGD 24m annually. So
before interest, the cash return is about
SGD 100m, or 6.7% on SGD 1.5bn of assets.
10-year Indonesian government bonds
currently yield 9.1%. Thus, like RHT, LMIR
cannot have any meaningful borrowings in
Indonesian rupiah, since the rate of return on
its Indonesian assets is below the Indonesian
government’s cost of capital. As with RHT, it
seems that either the assets are overvalued, or
there is a lot of room for operational
RHT’s quarterly results for 30 September
2013 show distributable income of
SGD 11.7m, or SGD 47m annualized, against
property, plant and equipment of SGD 580m.
Interest payments total SGD 2m annually. So
before interest, the cash return is about
SGD 49m, or 8.4% on SGD 580m of assets.
In comparison, 10-year bonds issued by the
Indian government currently yield about 8.7%.
Clearly, this means that RHT cannot have any
meaningful borrowings in Indian rupees at all,
because the rate of return on its Indian assets
is below even the Indian government’s cost of
capital! This leads to the inescapable
conclusion that either RHT’s assets are
materially overvalued and should be marked
down to a level where the implied rate of
return makes sense, or that they are being
poorly managed and need to be restructured to
earn returns commensurate with their
This brief analysis shows that the currency
mismatches at RHT and LMIR are symptoms
of a different and more serious problem: that
neither trust is currently able to earn a
reasonable rate of return on its assets, where
“reasonable” is defined as exceeding the
relevant government’s own cost of borrowing.
Unitholders might want to ask the managers
whether something is amiss. Common sense
suggests that the official valuation of the
trusts’ property assets, and the implied rate of
return earned on them, cannot both be correct.
So, in short, with regards to currency
mismatches, whether at the national or
corporate level, a simple rule of thumb is to
just avoid them.
An investor might argue that such issues are
already priced in, given that RHT trades at a
trailing yield of 10.6%. Unfortunately, a closer
look shows that this yield comes from
End 
Updated 24 February 2014
Keeping Your Capital Safe
Annex I
Updated 24 February 2014