8 July 2006
What's Ailing Asia - One Banker's Perspective
Speech by Mr Vincent Cheng, Chairman
The Hongkong and Shanghai Banking Corporation Limited
2006 Digby Memorial Lecture, University of Hong Kong
Medical Centre

Thank you Professor Wong. Good afternoon Ladies and Gentlemen. Let me begin by thanking The University of Hong Kong in general and the Department of Surgery in particular. Thank you for inviting me to speak on this special occasion. It is a great honour to be asked to deliver the Digby Memorial Lecture.

That said, I must admit I was initially unsure what I should talk about today. I might as well confess right up front that I have absolutely no qualifications to talk about medicine nor medical developments. And just for the record I pointed out as much when I was first approached to speak!

Professor Wong, however, assured me that this lack of medical knowledge did not matter. In fact, he kindly noted that at least two previous Digby Memorial Lectures were also non-medical in nature. Although this made me feel somewhat more at ease, it did not solve another problem. Namely, what should I talk about to such a knowledgeable audience.

Ironically, the inspiration for my topic today came from the very person this lecture is in honour of: Kenelm Hutchison Digby. In fact, from a speech that Professor Digby himself delivered back in 1940. I say 'ironically' because this particular speech by Professor Digby was actually a citation for an honorary Doctor of Laws. An honorary Doctor of Laws for a gentleman by the name of Arthur Morse. The same Arthur Morse whose portrait I see each and every morning when I come off the elevator on the 35th floor of HSBC's Main Building. The same Arthur Morse who once occupied the Chairman's chair at The Hongkong and Shanghai Banking Corporation.

So I suppose one could say that today I have the opportunity to repay an old debt. To say some kinds words about Professor Digby just as he did 66 years ago about one of my HSBC ancestors.

Now, as you know, Professor Digby arrived in Hong Kong in 1913 not long after this fine institution was established. Accepting both the post of Professor of Anatomy and of Professor of Surgery.

As you know, Professor Digby went on to spend more than half of his life - some 35 years - here in Hong Kong. In addition to his multiple roles at Hong Kong U, he was a surgical consultant to the Government and the public. An active member of the British Medical Association. A keen supporter of the Hongkong Chinese Medical Association.

As you know, Professor Digby is also fondly remembered as a great teacher and mentor. Someone who encouraged his students to read widely on scientific subjects other than their medical studies. Someone who ranked his duty as a doctor above self. Someone who was out-spoken yet at times quite shy, but who was always a perfect gentlemen.

What you may not know, however, is that Professor Digby - it would appear - also had a rather wry sense of humour. I discovered as much when I read that speech Professor Digby gave 66 years ago. For example, in his remarks the Professor praised Arthur Morse for various attributes. Including the fact that lady customers would pay unnecessary visits to the Bank just to catch a glimpse of Mr Morse!

Professor Digby also, however, addressed more serious subjects in this 1940 speech. Including the fact that Hong Kong was facing an uncertain future as war was spreading around the world. Professor Digby acknowledged that Hong Kong was fortunate so far, as the barbaric conflict had yet to reach its shores.

Professor Digby went on to point out - and this is where the wry humour comes in again - that during such uncertain times: "There must be many wealthy men in this Colony, some of them seeking refuge here, who are at a loss to know where to place their money safely. I would ask them what better investment for their children and for prosperity, what nobler use of their money could they make the endowment of a seat of learning."

Indeed, it was these very words from Professor Digby which provided the inspiration for my topic today. After all, there must be many wealthy doctors in this faculty, some of whom are seeking refuge in this lecture, who are at a loss to know where to place their money safely!

Joking aside, I want to speak to you today about something that is ailing many in Asia. In particular, many retail investors. Truth be told, there are numerous ailments hurting retail investors. From individuals not starting to put away their money early or regularly enough. To people not taking into account what inflation will do to the value of their portfolios in 25 or 30 years.

For the purposes of my talk today, however, I am going to concentrate on what I consider to be four of the most serious ailments which could impact the long-term financial health of many individuals. Perhaps even some in this room.

The first such ailment on my list is individual investors trying to guess the next hot market. Many try to do it. Very few are successful. And it is indeed the rare individual who has any sustained success at it. In fact, several years ago The Economist magazine ran a very entertaining article to illustrate this precise point. I dug up a copy because I want to share some of it with you.

The article told the story of a brilliant but fictional - let me emphasise fictional - investor by the name of Felicity Foresight. Born in the United States in 1900, Ms Foresight apparently discovered at an early age that she possessed perfect foresight about the performance of markets around the world. Consequently, during the period between 1900 and 1999, Ms Foresight invested all of her wealth at the beginning of each year in the one market and asset - shares, bonds, cash, property, precious metals and so on - which was going to have the highest return over the next 12 months.

Over the years, Ms Foresight invested in American shares, French shares and silver on many occasions. But in 1931, as The Economist noted, this imaginary investor wisely put all her money in American Treasury bills. The reason being she would have known that share and bond prices were going to plunge everywhere that year. The fictional Ms Foresight was, of course, also able to time her entry and exit into and out of gold perfectly in 1974 and 1975. And she went into and out of the best emerging markets at the best times. For example, she held Hong Kong shares for the year 1970 ... and again for the year 1976.

During one particularly unpredictable period near the end of the last century, Ms Foresight would of course have had the foresight to put all of her money into a different market at the beginning of each year for 10 consecutive years. She started with all her money in Austrian shares for 1985. Then went to the Philippines for 1986. Over to Greece for 1987. Indonesia for 1988. On to Turkey for 1989. Then Venezuela for the year 1990. Argentina for 1991. To Thailand for 1992. Poland for 1993 for a whopping 754 per cent return. Brazil for 1994. And for 1995 invested everything in Swiss shares.

Clearly, the creative writers over at The Economist made up Ms Foresight to make a point. That yes, one could rack up some impressive returns if they can consistently pick the next hot market or asset. What should also be clear from this fictional example, however, is that it would impossible to do so year after year after year.

Simply put, there are too many variables. Particularly in today's complex markets and interconnected economies. And that doesn't even include the impact of numerous big events which are impossible to predict. Think 9-11, Iraq, SARS, and so forth.

The second and somewhat related ailment I want to highlight is individual investors trying to time the market. Most believe the basic rule of successful investing is to buy low and sell high. Yet there is ample evidence to suggest many retail investors do the exact opposite.

Consider market volumes here in Hong Kong. Whenever there is market growth, a slight market adjustment or for that matter a large IPO offer, volumes tend to rise. We saw it in February of this year as the market started its bull run. Again in May when the Hang Seng Index reached its high. In other words, such increases in volume suggest that many retail investors in Hong Kong are in fact buying high.

However, even if a person does believe they somehow timed a market exit correctly, the question remains: will they time the re-entry as correctly? Indeed, was it the really the right time to exit? Is there a right time to exit?

To answer these questions, consider one of the infamous stories from the spectacular market crash in 1929 that led to the Great Depression. As legend goes, on Monday the 28th of October 1929, the eve of so-called Black Tuesday, silent film actor - Charlie Chaplin - was having dinner with the famous composer Irving Berlin.

Apparently at the time Mr Berlin had some US$5 million invested in the American stock market. A market which had posted gains of 37 per cent in 1927, 44 per cent in 1928 and was up by another 28 per cent over the first 10 months of 1929.

Mr Chaplin, meanwhile, reportedly had sold all his stocks the year before and was trying to convince his friend to do the same. But Mr Berlin didn't listen. The next day, of course we all know what happened, the markets did crash and the Great Depression was on.

What this legend suggests, of course, is that Mr Chaplin was either a genius, or at the very least, very lucky at timing the markets.

However, as one investment commentator pointed out a few years ago, while Mr Chaplin could brag about timing the market, it was the buy-and-hold approach of Mr Berlin that was - in actual fact - the better strategy over the longer term. Assuming Mr Berlin held a broad-based portfolio of US stocks, he would have started out with some US$2 million in 1926. This would have grown to the $5 million by October 1929. Of course, all of this gain and more would have then been lost with the market crash. In fact, by 1932 Mr Berlin's portfolio would have equalled just US$1.3 million, down almost 75 per cent from its peak.

However, if Mr Berlin didn't flinch. If he stayed in the market, he would have recouped all of his original losses by February 1937. Another eight years later, in 1945, his portfolio would have grown to total US$7.9 million. To take this story to the extreme, if Mr Berlin had maintained his portfolio as was - right up until his death in 1989 - it would have been worth US$1.1 billion. The moral of this story is that time in the market matters more than foolishly attempting to time the market.

For a more current and more local example, consider what would have happened if you as an investor had tried to time the market in Hong Kong between 1981 and last year. For the sake of simplicity, let's assume your investment was linked to the Hang Seng Index rather any particular company or companies.

Between 1981 and 2005, the average annualised return for the Index was over 13 per cent. However, if you were out of the market for just 10 of the best days during all of this time, your average annualised return would have dropped to just under 8 per cent. Meanwhile, if you were out of the market for 20 of the best days during this period, your annualised return would slip further to under 4 per cent. And worst case, say you happened to miss out on just the 30 best days over this period of more than 290 months, your return would have gone from positive 13.8 per cent annually to negative 0.3 per cent.

All of which suggests that some people may be right when they say the best time to sell is never.

Moving on. Ailment number three on my list: lack-of-diversification-itis. As doctors you can probably guess what this infliction is. Investors who are attracted to one area or even to several areas that are directly or indirectly linked. For example, say someone invests in different things - shares, property and so forth - that are all linked in some way to Hong Kong. By doing so, they are bearing a relatively higher risk than an investor who is diversified both in assets and in terms of geographic spread.

For the record, HSBC recently did a survey of some 1,000 current investors in Hong Kong. What we found was that Hong Kong stocks continued to be, by far, the most popular local investment. Unit trusts and foreign currency related investments finished a distant second and third respectively. Bonds, CDs, structured products, and gold were among the other investments mentioned, albeit all with a relatively low response.

What was most disturbing from a diversification point of view, however, was the fact that equities in the US and Europe were so insignificant in so many portfolios that they didn't even register statistically. In other words, although the United States and Europe are major overseas markets, many individual investors here seem to ignore them almost completely. Indeed, statistics from the Hong Kong Investment Funds Association confirm as much, with investments in North American equity funds for example, accounting for less than 1 per cent of gross retail sales in Hong Kong in 2005.

In short, many individual investors tend to be unbalanced. They tend to focus on what our CEO of HSBC Investments refers to as hot products or sexy single-country themes. Which of course, is not a bad thing provided it is only a small portion of one's portfolio - 10 per cent for example. Or even 20 per cent in so-called play money if an investor has a high tolerance of volatility. The remainder, however, should be invested in core long-term investments that provide solid if unspectacular returns. Returns which of course compound over time.

The fourth and final ailment I want to highlight today is the belief that some individual investors have - namely that they can do it all on their own.

Back to the survey I mentioned earlier. Out of those investors we talked to recently in Hong Kong, seven out of 10 people polled said they rely on advice from relatives and friends when making their investment decisions. Meanwhile 4 out of 10 said they also listen to commentaries from renowned analysts. Or take into account advice from brokers and investment advisors. As for which of these sources of advice investors deemed to be the most valuable: advice from relatives and friends ranked the by far the highest.

Other surveys have resulted in similar findings. Last month - as you may recall - one local poll of IPO subscribers reportedly found that many were subscribing simply because everyone else was doing it. In fact, following the herd was the second most cited reason for investing, behind confidence in the company. From what I recall, advice from a professional investment advisor didn't even make the list.

In short, many investors tend not to consult professionals about decisions that can have dramatic impacts on their long-term financial position. Which, I suppose, could even be considered akin to people making critical health decisions without consulting people like you.

For many - perhaps even some in this room - it comes down to a lack of time. One of my Bank's private client advisors found this out firsthand a few years ago when she arranged to get together with a doctor here in Hong Kong to discuss his portfolio.

This doctor - who shall remain nameless! - was an anaesthetist. Their meeting was scheduled for 7:30 in the evening, at a local Japanese restaurant, which shall also remain nameless! The theory being that there would be less interruptions there than at the doctor's office during the day.

But 7:30 came and went with no doctor in sight. Just before 8 pm, my colleague received a telephone call from a nurse, passing on the doctor's sincerest apologies. He was tied up in the operating theatre but should be there soon. Just before 9 pm, my colleague's telephone rang again. Again it was a nurse calling on behalf of the doctor. It seems the procedure had not gone as quickly as planned and the doctor was now going to be a little later. Would she mind waiting? No, my colleague said.

Another hour passed and still no sign of the doctor. Then my colleague's mobile phone rang once more. It was the doctor calling to apologise personally and to say that he was going to be on his way soon.

Finally, at 10:30 pm the anaesthetist arrived at the restaurant. Exhausted and hungry. Fortunately for him, my colleague had the foresight to order his dinner before the restaurant's kitchen had closed. After once again apologising for being so late, the doctor promptly asked my colleague what shares she thought he should be buying. My colleague could not help but point out that if he was having trouble finding the time to eat, how in the world could he have the time to choose individual securities.

Being highly educated - as all doctors are! - this anaesthestist recognised the irony of the situation. Here he was trying to decide if he should turn his investment portfolio over to a professional manager or continue to manage it himself and he couldn't even find the time to manage his own dinner.

Clearly, busy professionals like him - and perhaps some of you - probably find it difficult to find the time to keep track of daily market movements. Or for that matter, to even have the time to answer constant calls from an investment advisor seeking your approval to buy or sell. Which is perhaps why some prefer to give their financial advisors the authority to manage one's investments on a discretionary basis. But I digress.

Conclusion
The point I want to make today is straightforward.

Individual investors have choices to make. They can continue make investment decisions based on what friends and relatives say or do. They can resort to consulting taxi drivers or the shoeshine guys on Theatre Lane for their views on the latest trends. They can try dartboards or find some friendly monkeys, which have been known to beat the market with their random selections. They can even log onto websites like trading-markets-dot-com, where they can follow the stock picks of Playboy playmates. Including one - I am told! - who is currently more than 20 per cent ahead of the S&P 500 and who somewhat ironically is studying to be a doctor.

Alternatively, they can leave it up to the professionals. Contently allowing others to follow the daily ups and downs for them. Happily knowing that the bulk of their investment portfolio is based on returns over the longer term. Perhaps even prudently diversifying their hard earned money both geographically and by asset class in the process, through a fund of funds for example.

The best choice - I would submit - is obvious.

That said, please do not think that I am trying to suggest that all of you should be lining up at HSBC tomorrow seeking financial planning advice. I am not. Rather what I am saying is that I firmly believe investing is best left to the experts. Just as I am sure you believe medicine is best left to you, the doctors.

However, if you really want to manager your own portfolio, I would suggest the following. First, spread you portfolio - hold cash, equity and property. Second, invest in companies with good management and track records. You may not get very rich this way, but it sure offers you protection for your hard earned wealth.