ASK Dr. NOET
Yield is not all that matters
By Dr. Johnny Noet Ravalo
INQUIRER.net
First Posted 10:15:00 04/30/2008
Filed Under: Investments, Personal Finance
(Part eight of a series)
I have an investment in Philippine Treasury Bonds, which will mature in September 2010. Should I redeem my money before the maturity date? Or would it be better to trade it through the Philippine Dealing System? – Jojo
When an investment opportunity comes our way, the main pitch is its rate of return. Those in the know often speak of “risk-adjusted” rates of returns to get a better reading of the “real” attractiveness of different instruments. A whole array of measures has been devised just for this purpose.
For retail investors like you and I, however, this language is too foreign and largely inaccessible. Even if we wanted to speak the language of risk adjustments, many of the required parameters are not publicly available. The best that we can get from our financial agents are terms like “indicative returns”, “estimated IRR” and perhaps “historical return” for instruments that are already selling in the market. For stocks, price-earnings ratios are often used as a guide for the future.
A great deal of caution about these terms is helpful. The term “indicative” translates to “best guess” and I have no clue how the financial agent got to his conclusion. IRR assumes an unchanging market condition so I really am not a believer of this parameter. History is good ... except of course that it has this nasty habit of changing when you least expect it. As for P/E ratios, they would be helpful only if we had a good benchmark.
For these reasons, I personally place a very high premium on asset liquidity. I need the peace of mind that I have the option to sell my investment any time I need to do so. In addition to being “tradable”, I need to have a reasonable sense that I can liquidate my investment without having to take a huge loss by selling it at a firesale price.
These two conditions are the hallmarks of a liquid instrument. This is just being practical. What comfort can we take from an instrument that promised a high rate of return if we do not have the option to get back our funds when we may need them?
This is the situation faced by Jojo. In principle, Retail Treasury Bonds are tradable in the secondary market. Tradability or liquidity is defined at the level of a particular instrument and not just for a product category en toto. Even though RTBs are tradable, some specific RTB issues can be more tradable than other RTB issues. Different RTBs have different coupon rates, different remaining term, different degrees of sensitivity to risk parameters and are valued differently by market participants depending in part on the latter's outlook of market dynamics.
To liquidate his RTBs or T-bonds, Jojo needs to designate a broker who can handle the transactions. By law, it is the broker who will enter Jojo's “sell order” through a designated terminal. It is through the information entered into the terminal that the Over-the-Counter (OTC) market will come to know that there is an interested party who wants to sell (or buy) a particular instrument. At the moment, orders are entered based on price and it is the platform that will try to match buy and sell orders using a prescribed rule-based algorithm.
Offhand, I would not know how liquid Jojo's RTBs are in the market today. Again, it is not the product class (RTB) by itself but the specific issue --- each issue has a specific securities code -- that is relevant for liquidity purposes. The public should know which issues are actively being traded and what would be the spread between the buying and selling rates. These are the most basic indicators of liquidity.
The brokers themselves would have a sense of this information on their OTC terminal. I understand why the SEC requires non-sophisticated investors like you and me to go through brokers: Brokers are professionals who are expected to act in our best interest and process information such as liquidity indicators for our use. That is perfectly understandable and within the confines of best practice. Personally, however, I would still like to have the information on hand so I can at least try to form my own opinion. Having the information does not prevent me from working through my designated broker anyway.
To me, this limited information is a major weakness of our market today. Unfortunately, in the absence of this information, we are left to either rely on the financial suggestion of others -- which could be either good as gold or as late as a bandwagon -- or go back to the imperfections of deciding based on best-guess rates of return.
The net effect is that once we have the investment in our portfolio, we either hold it to maturity or rely on our good fortune that market conditions are in our favor when we decide to sell.
(Have a question for Dr. Noet? Email personal_finance@inquirer.net.
(Noet Ravalo is a macro-financial economist by practice and profession. He was chief economist of the Bankers Association of the Philippines until 2002 and has since been doing consulting work. Since 1994, he has been asked to provide technical inputs to both the Senate and the House of Representatives on various economic and financial legislation, some of which will have big impact on Filipinos' personal finances.)
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