As much as some people would like you to think, index investing isn’t always a bed of roses. If you are investing in the Straits Times Index ETF that is made up of 30 component stocks, we are going to have to contend with geographical concentration risk and industry concentration risk.
As blogged about previously, as at 31st December 2015, Singapore has a weightage of only 0.45%, which is really a drop in the ocean compared to the entire world. We are essentially a “penny stock”. In addition, a handful of them are in fact related companies.
Also, remember that we have the three banks of Singapore – DBS, OCBC and UOB – together making up 1/3 of the entire ETF weightage at 35%. As a whole, financials took up 56% of STI.
As it stands, investing in our local index – The Straits Times Index – isn’t quite the same as the diversification of the S&P 500 huh? We are playing a whole different ball game with different set of rules here – consider adding a global index into the mix for diversification.
Customer Concentration Risk
I was browsing through an article on a local stock the other day, when it highlighted that it had a major customer concentration risk – when a single, major customer makes up the bulk of the revenue.
This got me thinking – what if we looked at it from the perspective of a country? Google helped me to fill in the blanks.
In earlier reports (refer to Reuters/ANZ/Bloomberg charts below), it showed the increasing dependency of Singapore on China from 2000 to 2013. Exports to China as a percentage of GDP has grown tremendously – three times, from 6% to almost 18%. Correspondingly, any shock to China’s growth would definitely reflect in our own GDP growth.
In this instance, it appears that China, the world’s second largest economy after the US, is one of Singapore’s major customer. It is common knowledge that in Southeast Asia, Singapore is the most vulnerable to a China slowdown. Just like water can float a vessel, it can sink it as well.
Don’t Just Hear. Listen.
Index investing typically advocate ignoring noises and staying the course, but I think differently in terms of acquiring knowledge. Be skeptical – see clearer, and listen more.
Understand how the world is always changing and yes, indexes can go scarily wrong. Remember the Nasdaq dot-com bubble and lost decades of Japan? The crash came right at the peak of euphoria. One can never discount the possibility that one day, the Singapore index will find itself in the exact same situation.
With our high level of dependency on China, we would be interested in knowing this -is the awakening dragon falling into another slumber? What is happening to China’s slowing economy and diminishing labour force? The following video paints a real and unique problem to China in this day and age.
The Merlion has rode the flying dragon which has helped to carry on the amazing Singapore success story. We must be wary of the possibility that the end of the China miracle could be right at our doorsteps.
China Index – In Or Out?
While China and its markets are too enormous to ignore in the long run, there are lingering concerns over the stock market volatility with large fluctuations and government interventions e.g. trading halts when it comes to stopping the equities rout.
MSCI would be greatly risking their credibility by allowing China into its Asia indices when there is still so much state intervention and control over China’s bourses – Angus Nicholson, Melbourne-based analyst at IG Ltd
As MSCI mulls over when (earliest in June 2016, as it is only a matter of time) mainland Chinese shares would be added to its benchmark, index investors would do well to heed the warning signs – why has China been repeatedly rejected for inclusion into MSCI indices?