Top-Down Investing – a practical example

Word equity under magnifying glass — Image by © Image Source/Corbis

Top-down investing is a is an investment approach that involves looking at the overall picture of the economy and then breaking down the various components into finer details. After looking at the big-picture conditions around the world, analysts examine different industrial sectors to select those that are forecast to outperform the market. From this point, they further analyse stocks of specific companies to choose potentially successful ones as investments[1].

To many regular investors this might sound very complicated and difficult to achieve without using advanced analysis and statistical tools. In reality the analysis could be made as complex or as simple as one likes, as long as the overall results and assumptions taken make sense. Complexity does not necessarily mean that one has a better end result. This post aims to give a practical example that is easy to follow of how top-down investing works. It also goes on to mention some specific equity ideas. The end result will give some real examples of equities one can buy in order to increase exposure to the crypto-currency world which is very interesting but also very risky to buy into directly.

The US Economy

Since the focus of the exercise is to arrive at equities that a regular investor can easily get access to it made sense to focus on US equities. As the focus is on US equities then the starting point is the US economy. The US is considered to be a consumer driven economy meaning the economy is dependent mainly on consumer spending. The gross domestic product (GDP) of a country measures the market value of all final goods and services produced by an economy over a particular period of time. If we look at the GDP of the US we find that around 70% is made up of consumer spending. The other 30% or so is made up of Government Spending, Business Spending and Net Exports of the country (Export less Imports) combined.

As the economy is continuing to show signs of growth and the economy is so dependent on consumer spending one could easily arrive at the conclusion that consumer spending is expected to keep growing. Hence, the next step in the link is to find ways of investing into equities that are somehow exposed to consumer spending. That is quite a big list since many companies service regular consumers. Thus, one would need to narrow down further to find more specific entities to invest into. Moreover, two companies might be involved in the production of the same goods/services to the same type of consumers but still perform differently. If consumer spending increases the entire sector should improve, but not each company will benefit equally and not each company is in the same shape – thus other factors also need to be considered.

Refining the Selection

So, let us now add something else to the mix. There has been a fair share of hype on the crypto-currency universe, especially in the last year or two – see my previous post relating to this here. Many investors would like to invest into this world but are not comfortable with the direct instruments available due to the high volatility and high risk involved. So how can we combine the analysis we discussed above on consumer spending and the exposure to crypto-currency investing – the answer: by looking at equities that are exposed to both sectors.

A prime example are the payment service provider firms such as Visa and PayPal Holdings. Whether you buy online, buy at the supermarket, travel abroad or simply ride a taxi you could easily pay for your goods or services through one of these payment companies. Furthermore, when buying crypto-currencies people can use these same companies to convert from their hard currency (U

SD, Euro…) to the respective virtual currency such as Bitcoin, Ethereum and others. Just to get an idea of the amount of transactions that are processed by such companies, PayPal is said to handle 193 transactions per second which translates into 16.7 million transactions per day. When it comes to Visa the figures are even more great, reportedly 24,000 transactions per second which translates into over 2 billion transactions per day.

The Bottom Line

Therefore, starting from the analysis of the US economy and working our way down we have arrived at examples of equities that a regular investor could easily invest into. It goes without saying that one should not simply go and buy a bunch of shares of the two companies mentioned and one should always seek professional investment advice to ensure that the investments they are considering are suitable for them. The author held positions in the equities mentioned at the date of publication which may be sold off without notice.





Buying into Crypto Currencies – Without Buying Crypto Currencies

Many people have asked me about what I think about the whole crypto-currency world and if I think they should invest into such virtual currencies. I have attended interesting seminars that discussed the topic in detail and have done my own research on the subject to understand how it all works. Although it is not too complicated to understand the mechanics of what crypto-currencies are and how they work, one must first put in a fair amount of research to in fact understand their universe. Given that crypto-currencies are a relatively new concept they cannot really be compared to other assets, although they will share some traits with other new/disruptive technologies.

 Fad vs Serious Investment

One of the first things people think about is whether this is just another fad that is in the news today but gone tomorrow? or is this the best thing since sliced bread that is destined to change the world as we know it? In reality, nobody can truly say. What is certain is that crypto-currencies have grown in importance to a level where even your local butcher is talking about it. Hence, there is no doubt that virtual currencies are being talked about and people are eager to get a slice of the pie by finding the best way to invest into this world.

This creates a dilemma for potential investors since on the one hand they see the returns that were registered over a small period of time with virtual currencies – this creates the biggest psychological problem, i.e. the lost opportunity. On the other-hand people are also aware of the high volatility of such currencies when they read headlines that this or that virtual currencies went up or down 20% in one or two days. This high volatility usually scares away potential investors, especially those that are not that interested in getting to know how virtual currencies work or how they could be used, but just want to make a quick return like that guy on the Facebook ad did. Their normal course of action would be to ask their investment advisor.

Of course their investment advisors have their own issues with virtual currencies. Knowing that the product is not easily understood by most retail clients the issue of complexity comes up. This means that it is difficult to prove that a client truly knows what he/she is getting into if they were to invest into virtual currencies. Coupled with the complexity issue you have the high volatility issue which means that the instrument is a highly risky one. So the main issue is basically that from a business risk point of view it does not really pay off for a licensed investment firm to recommend to ordinary retail clients to invest into virtual currencies.

So does this mean that there is no safe way to try and ride the crypto-currency wave? Is there no way that clients can get exposure to virtual currencies at an acceptable level of risk? Is there no way that investment companies could give recommendations to their clients to invest into crypto-currencies? Like in many such situations, there is always a way.

How to invest in virtual currencies, without investing in virtual currencies

Although doing it directly presents an amount of hurdles for both investors and financial advisors, going the indirect route is still an option. One thing that will come to mind for most when thinking of an indirect route is to invest through a fund or ETF. This is in fact one option that has the advantage of adding diversification by investing into many different currencies and not just buying one or two currencies. Thus, the logic would be that if crypto 1 issued by ABC Tech was a flop and ended up with no value, crypto 2 – 100 are still in existence and the risk has been spread. This sounds good, but in reality this just helps with the risk affecting just one virtual currency. In real life we expect bad news on one of the currencies to drag down all the rest. So this might still not be the best option, especially since such a fund would be expected to have a high level of volatility (risk) given the high level of correlation (similarity) of the currencies.

Thus, one needs to go a step further and think more broadly. Of course, investing into the shares of the companies that have issued virtual currencies is not really an option most of the time since they would have issued their “shares” through an initial coin offering and not by issuing traditional shares. Thus their “shares” are basically the virtual currencies they have issued. This has led me to conclude that the best way for most investors to invest into virtual currencies is to invest into the shares of companies that are somehow exposed to this market. So the logic would be to invest into shares of well-established firms, that are highly liquid, that trade on reputable stock exchanges and that already have a track record.

One may look into the shares of certain technology companies that are involved in the production of the virtual currencies. Alternatively, one may look at marketing companies that are involved in the Initial Coin Offering or Initial Token Offering markets since no crypto currency can be launched without having a good marketing strategy. Or else, the area that is interesting me the most is to look into firms involved in the payments sector. In order to buy cypto-currencies most people would need to send a payment using a hard currency such as the US Dollar or Euro. To send their “real” money they need a payment company to do the transfer for them. Hence, such companies have already experience good growth directly linked to the crypto currency world and still have more to gain as demand for such currencies keeps growing.

The Bottom Line

So in conclusion, there is a safer way of getting exposure to the crypto currency world without having to take on the high risk associated with directly investing into such currencies. The ideal portfolio of companies to invest into in order to get this indirect exposure will depend on a number of factors. But the important thing is that there is a solution to the dilemma and it is a solution that investment advisors can more confidently help their clients with.

As usual please take note that nothing in the post is to be interpreted as investment advice. The views are my own and I would urge anyone considering to invest into anything discussed in this post to get professional financial advice. For any queries about this or any other article on this site, or for any recommendations on future topics, please feel free to contact me on


How Regulation is Shaping the Technological Revolution in Finance

We hear a lot nowadays about how Artificial Intelligence (AI), algorithmic trading, robo-advisors, blockchain and other technologies are shaping how investment services firms operate and even how investments are structured. There is no doubt that technology has had a considerable effect on virtually every industry and that new technologies will continue to develop and cause change and disruption to the “old way of doing things”. When it come to the financial services industry however, which is a highly-regulated industry for obvious reasons, one must keep in mind how the regulations will directly or (sometimes more importantly) indirectly allow the technology to operate.

You can have the best technology in the world, capable of reducing costs drastically, of improving productivity to new heights and capable of presenting the best returns for clients consistently – but you must never underestimate the restraints of regulation. Unfortunately, as more and more regulation is developed we see the concept of proportionality always decreasing and in some instances non-existent. Thus, if a start-up has managed to develop the best investment idea using the best technologically advanced method, but fails to get the regulatory approval to operate – it is essentially useless.

Getting Licensed

Some countries like the UK, the USA, Switzerland, Dubai and Australia have tried to bridge this gap by offering what is known as a “regulatory sandbox”. These initiatives aim to give a space where financial firms or more specifically Fintech firms can test their innovations in a less restrictive regulatory environment for a limited period. Although the initiatives a very good step, one should keep in mind the fact that once such companies would like to fully open-up for business they would still need to abide by the regulations just as other companies would. The initiative helps on the front of getting licensed and developing in a way that will get the entity compliant in a more efficient manner, however getting licensed is not the end of the process, but the beginning. Financial companies are subject to capital requirements, on-going monitoring, risk-management, internal audit requirements and must also abide by other regulations besides the ones directly applying to finance.

Beyond the Initial License

From a capital requirement perspective, the current situation is that a 3-person start-up has to abide by the same capital requirements of a multinational firm that holds the same type of license. There has been an initiative from the EU front to try to make a distinction between the systemically important entities and the smaller firms that pose a much lower market risk, however there have been no conclusive results yet and it could take years to ever get to a workable solution. An important feature of the capital requirements of such firms which is particularly punitive on Fintech and other technologically centred firms is the fact that intangible assets are deducted from the capital base of a company. For capital requirement purposes, the fact that firm has a highly valuable asset in the software and goodwill it has created through its technological advancement is actually penalised. This is a clear example of how regulation is going against the technological advancement of the financial sector.

Another factor to consider is that financial regulation is just one piece of the puzzle. Entities and individuals operating in the industry must also abide by other regulations. One source that continues to grow in importance is the tax regulation. Pressure is always growing for more substance, more tax reporting, more client details – these all add up to more costs. If a start-up fails to factor in these costs it could become insolvent due to the higher ‘un-exepected’ costs.

The Bottom Line

In conclusion, it is safe to say that regulation is having an effect on how the financial services industry can develop. Although certain technological advances are here to stay and will continue to develop as the years go by, their disruption to the more traditional way of doing things is severely hampered by the initial and ongoing regulatory requirements. Thus, the regulatory environment is a very important area to focus on for countries that would like to see the development of their financial industry embrace the technological advancements and take advantage of them. Only once this is done will we ever see the true potential of the Fintech revolution. This is not to say that regulation needs to be lax and more self-regulation is needed, however a more adaptive system is definitely a requirement. The system needs to still incorporate the basic overriding aim of safeguarding stakeholders, most importantly the clients. However, it must be adaptive enough to regulate different entities differently on a risk-based approach and in a proportional manner.

Beyond Malta’s Financial Services Industry

There has been a lot of news lately concerning the whole #MaltaFiles incident with a number of journalists, bloggers, industry experts and others covering this topic. I do not wish to get into the merits of the whole case but would like to highlight the strategic timing of the whole incident just as the country is in election mode and following the #PanamaPapers and corruption allegation at the highest level of governance of our country.

There is no arguing that our country has suffered a reputational blow over all these incidents. Regardless of one’s political views and who one blames for all this, the fact of the matter is that we are all affected by these incidents and we all must act collectively to restore our reputation.

With this post my main aim is to show how all industries are affected by our reputational damage and this is not simply something that has to do with the financial services industry in isolation.

The Multiplier Effect

First of all it is important to recognise the interconnection of industries and the multiplier effect that an industry has on the whole economy. If we take the financial services industry, one may read how it makes up around 15% of Malta’s Gross Domestic Product (GDP) – this means that statistically the income generated by this industry is roughly 15% of all income generated by Malta’s economy. That is just the direct effect – it is estimated that the indirect effect can raise the financial services industry’s contribution to GDP to as high as 30%.

But How?

Easy – think of the residential rental income and properties bought by foreigners working in this industry. Think of the commercial premises bought or rented by companies and practitioners working in this industry. Think of the money that clients and promoters of this industry spend on dining and subsequent personal holidays to Malta. Think of the people who have relocated to Malta entirely and the amounts they contribute across the board to our economy through their spending. The cars they rent to get around or the taxis they hire while visiting, the flights they pay for and accommodation they take up while here.

Not Just Financial Services

It is also very important to keep in mind that the country’s reputation has a direct effect not just on the financial services industry but on any industry that is in some way or another linked to foreign direct investment. So this will include the manufacturing industry, the export and tourism industry, the meetings and conferencing industry, the software development and IT network servicing industry, the gaming industry and so forth. In turn, all these industries have a multiplier effect on the economy. What this means is that even the store keeper of a hotel, the maintenance man of a manufacturing company (like the large semiconductor manufacturer in Kirkop), the checkout person at the supermarket, the cleaning staff of a restaurant and so many other jobs are all affected.

One must also keep in mind the large amount of direct and indirect taxes employees and owners of these entities pay. Thanks to the collective contribution, Malta is boasting a budget surplus, low unemployment and a growing economy. These things do not develop following a short term initiative but are the fruits of medium to long term collective efforts. As many will appreciate, reputation is something that takes years to build but days to ruin. Thus, in these challenging times it is of the utmost importance to give this matter serious recognition and devote all necessary resources to maintain our good name.

The Government’s Role

Although it is true that the government of the day has a bearing on the overall progress of the country and its reputation we must not fool ourselves by thinking that it is solely the government’s role to do so. The private sector has to be proactive at its own initiative to safe guard the name and reputation of our country. One has to see beyond the political noise and mudslinging that only benefits the few and not the many. Regardless of one’s political views, having a situation where the Police Commissioner, the Attorney General, the Financial Intelligence Analysis Unit (FIAU), the Malta Financial Services Authority (MFSA) and other high ranking institutions, as well as the rule of law itself, coming into question, is highly unacceptable. Whoever is in power after June the 3rd should give this the utmost importance and work with industry experts (from the many different industries) in order to have a public-private initiative that can truly benefit the whole economy.

The Bottom Line

It must be recognised that as a country we are constantly in competition with other jurisdictions. If Germany can attract a company to open shop or expand its operation in Germany, then it will do its utmost to attract such business. To whine and complain that other jurisdictions are targeting us and playing dirty is futile. It is a competition, so one must expect the other players to be competitive and use whatever opportunity they get to make us look bad and make themselves look good. Of course this does not mean that we just sit back and accept whatever is thrown at us. We must be prepared for the competition and have strategic plans to defend our name. The current political scenario is putting us at a disadvantage for sure, but every country goes through political issues and no political system will ever be free from its drawbacks.

The upcoming general election has made the situation worse by increasing the political barrage and giving more ammunition to our competition who seek to portray us as an offshore country with shady practices. I will however end on a positive note, we all know that the allegations against us in relation to Malta being an offshore financial centre are untrue and hence we can defend our good name with the truth and with facts. Governance issues can be rectified by replacing the people who have caused the issues and the country’s reputation can be restored. One powerful tool all citizens have is their vote and they must use this tool in a conscientious way to choose the party and political representatives that they feel can best help us on our mission to continue developing our economy and restore our good name.


Attracting FinTech and other new Business Models to Malta

There has been a lot of hype over the last years to attract new types of businesses to Malta such as the FinTech (Financial Technology), WealthTech (Wealth Management using Technology), Algo-trades (investing using algorithms) and more recently Investment-based Crowdfunding Platforms. Rightly so, entities such as FinanceMalta have held several seminars and initiatives to attract these types of business and in fact their 2017 annual conference will be focusing on this theme.

Through this post I would like to give a brief description of these types of entities and to also provide some thoughts on the factors which could deter these types of entities from seeking to be registered in Malta. From personal experience of being involved in a start-up Fin-tech, Wealth-Tech and Algo-trading company Novofina I would like to shed some light on the difficulties faced in attaining a suitable license and remaining compliant to rules and regulations which are based on a one size and one type fits all regime.


FinTech can describe any financial services entity that uses technology to perform its service or offer its products. The technological innovation can be applied in different parts of the process from research, retail banking, investment selection and even crypto-currencies such as bitcoin. Technologies can include things like Artificial Intelligence (AI) that could be applied to investment instruments selection or to research gathering for estimating market sentiment for example.

Originally FinTech referred to technological innovations applied to the back office of banks and investment firms, nowadays it refers to a wider variety of technological interventions in the retail and institutional markets. The level of technology used varies depending on the type of company and the services it seeks to offer. It can range from mobile wallet systems to robo-advisor services. Even within a category of firm types the technologies applied can be wide ranging. For example, if we take the robo-advisory firms, you could have companies that simply use online data entered by the client to determine their risk profile, financial bearability and knowledge and experience in order to offer a bundled Exchanged Trade Fund (ETF) solution. You can also have so called forth-generation robo-advisors that use algorithm based trading in combination with AI in order to trade different investment strategies on behalf of clients.

An Algo-trader would use a mathematical algorithm that would be pre-programmed with certain rules in order to trade large amounts of instruments (example shares) on the market. The algorithm would be programmed to trade a particular trading strategy and configured in a specific way relating to price, position sizing, timing and risk-mitigating techniques. Thus, not all robo-advisors are the same and even more so not all FinTech or WealthTech firms are the same. This makes it even more difficult to fit into the local financial services regulatory framework and categories of licenses.

Investment-Based Crowdfunding

Crowdfunding, as the name suggests involves the process of gathering a lot of small amounts from a lot of people in order to collectively raise a larger amount. This can range from a simple project such as raising the funds to finance the publication of a book to more complex issues such as using the funds to invest into a new FinTech start-up through an equity stake. So far in Malta investment-based crowdfunding is not really possible since the current regulatory framework dose not really provide for this form of investment. However, we have seen some progress here with a donations-based crowdfunding initiative being launched that raises money against donations and can give back certain perks. There has also been a consultation paper issued by the regulator late last year which period had closed in March 2017. So we are beginning to see some progress here. A very interesting article for anyone looking to find more information on investment-based crowd funding can be found on the latest publication of the Malta Business Bureau here.

Barriers to Entry and Operate

It is a great initiative to attract the most technologically advanced financial services companies to Malta. However, there are certain issues that are hindering their entry and once operative, their operational viability. One of the largest barriers is the regulatory issue. Our current regulatory framework was not designed for these technologically advanced firms and the current situation is that these firms either fit themselves into an existing license category or else they are not welcomed. This is a major issue since it could be forcing firms to have in place certain items which are not applicable to their business model, are costly to maintain and would lead to deterring a potential newcomer from setting up shop in Malta.

To put it more simply, if a FinTech company would like to attain a license to provide services A B and C, why does it still have to apply for a license that caters for services A to G? Although there is some flexibility in the license application process and certain derogations may be applied it is still far from being an attractive preposition balancing investor protection and the reputation of the local financial services industry on one side and attracting the right players that could take the Maltese financial sector to a whole new level attracting cutting edge, niche market firms. On the other hand, the current regulatory framework may present certain loopholes for certain types of FinTech companies since the current regulatory requirements may not fully appreciate the different risks such firms pose to investors and the financial sector in general which could be quite different compared to more traditional financial services entities. Having said that, risk management has taken a much more prominent role nowadays.

With respect to the ongoing obligations of such entities once they have been licensed it is not logical that their capital requirements should be the same as those of other more traditional firms. To put it simply, certain investment services providers are subject not only to minimum initial capital requirements but also to on-going minimum capital requirements. This capital requirement is not simply a calculation of asset less liabilities, but involved certain amendments to arrive at the regulatory capital requirement. One of the deductions from an entity’s capital figure is its intangible assets figure in its balance sheet. Given that FinTech, WealthTech, Algo-Traders, Robo-Advisors and all the rest of these firms invest heavily in software and licensing of such software, and software is an intangible asset, they are currently being penalised for doing so. So on the one hand we want to attract the most technologically advanced firms and on the other hand we are telling them that their software is worth nothing and must be deducted from their capital. To be clear, this is not simply imposed by the local regulator but comes out of the EU Capital Requirement Directive. Simply blaming the EU legislation is not a solution however and when it comes to these technologically advanced firms it is even more so that we are not simply competing just with other EU countries but the whole world. Being online based makes it even easier to setup anywhere in the world with a decent internet connection.

Another problem we are facing locally is the shortage of talent. The gaming industry has brought many benefits to Malta, however it has also created a shortage in IT developers. Administrative staff is also becoming a problem for some firms, especially since most FinTech firms are start-ups and thus have a higher risk of going bust compared to the larger players in the industry. Another problem I see locally is the lack of promotion and support for being an entrepreneur. This last obstacle may the most difficult to overcome since it could be considered a cultural issue. However, with proper incentives and moral support from a young age there is no reason why we cannot produce more students who desire to become business owners. Interestingly enough, investment-based crowdfunding could be a very good avenue where such budding entrepreneurs could find funding to start off their project until they get to a level where other sources of finance could become available to them.

The Bottom Line 

All-in-all I truly believe that Malta has the potential to become a major player in the FinTech arena. It has already proved itself in the fund industry and the online gaming industry for example and there is no reason why a market for FinTech and other technology based financial services firms should not also be successful. However, to reach such a realisation there must be more support and initiatives for such firms to choose Malta. Some barriers like certain regulatory issues are not entirely under our control. However, if our regulator decides to gold plate an EU directive this would hurt our chances of attaining success in this sector. One such example that comes to mind is the “holding and controlling” of clients’ money requirement locally, when the EU directive speaks only of “holding” clients’ money.


The views expressed are the personal opinion of the writer and do not necessarily reflect the opinion of any entity the author is associated with.

Investing in Equities

Investing in equities, stocks or shares all refer to the same thing – being a part owner of a company as a shareholder and participating in the profits and losses of the company(ies) you invest in. There are two main ways of making money when investing in equities:

  1. Capital Gain
  2. Dividend Income

With respect to capital gain this can be done in more than one way. The simplest form is to buy an equity at a low price and then sell it at a higher price. However, one could also short an equity. The desired result is still to sell high and buy low, but instead of first buying the equity and then selling it the process is done in reverse. Thus, if one would expect an equity to fall in price one could sell the share (by essentially borrowing the shares from one’s broker) and then buy them back at a later stage.

The risks associated with shorting are higher than the traditional way of buying and then selling later (known as “going long”). The reason is simple – if one buys €10,000 worth of shares the maximum one could lose is their €10,000 since a share cannot have a negative price and go down to €0 at most. In the case of shorting however the downside risk is much bigger. For example, if I sold €10,000 worth of a share at a price of €100 per share – so I would have sold 100 units (€10,000 divided by the price per share of €100) and the price subsequently skyrocketed to €250 per share and I was forced to close my position I would have to pay 100 multiplied by €250 = €25,000 to buy those shares. So deducting the €10,000 I would have gotten when I would have shorted the same shares, I would end up with a loss of €15,000, which is higher than the original amount I traded.

The above example is simple way to see the difference between the two methods of going long and of shorting. However, they are very extreme cases and are not as likely to happen. This is not to say that a company cannot go bankrupt (example after a major scandal) or cannot have its shares price skyrocket (example after the announcement of a takeover). However, through some simple risk management techniques such as sticking to the larger capitalised stocks and investing a portfolio of different shares, such extreme cases can be minimised and their impact on your overall wealth can be reduced significantly.

Can equity investing be profitable?

The easiest way to answer this question is to look at a broad-based index such as the S&P 500 which is a US stock market index based on the market capitalisations of 500 large companies having equities listed on the NYSE or NASDAQ.

The chart below shows the performance of the S&P 500 over the last 5 years from 5 April 2012 to 4th April 2017

*Source: Google Finance

As can be clearly seen form the above chart the performance over 5 years of this equity index has been 67.57% equating to a 13.514% return per annum. Thus, it is true that double digit returns are still possible on equities and it has been the case for the last five years, based on real figures. What if we increase the time frame, perhaps the last 5 years were exceptional? The chart below shows the same S&P 500 index but over a 10 year period from 5th April 2007 to 4th April 2017. Hence, it also includes the latest major financial crisis:

*Source: Google Finance

Some interesting points to note:

  • The 5 year and 10 year return on the same index are very similar which means that the annual equivalent of holding the same index for 10 years was 6.611% per annum (i.e. around half the last 5 year annual equivalent).
  • The price can go down and it can go down significantly. Anyone who bought at the highs of 2007 and was panicking in early 2009 and decided to sell could have lost around 50% of their investment.
  • Investing in shares is a long-term game – the same person who invested in the highs of 2007 and decided to hold on to their investment would be gaining 66% currently.

Does this mean that one should always invest in a broad range of equities such as buying an index fund that tracks the S&P 500 in a passive way?

Not necessarily. Increasing the amount of equities within one’s portfolio is a good thing only until a certain point. Diversification (the lowering of risk by spreading the investment across different equities) will be a positive factor, however the amount of gain through diversification is reduced further and further the more equities one adds. One must consider that although increasing the amount of equities lowers the impact of the negative trades, it also reduces the impact of the positive trades. Furthermore, one also should consider other factors such as transaction costs and costs for maintain the portfolio. The smaller the amount that is invested per share the larger the cost since most brokerage firms will have a minimum cost per share and some also have safe-custody fees which is a fee for holding the equity on your behalf.

Another factor to keep in mind when analysing the example above of investing into the S&P 500 is that we were just considering the more traditional method of investing buy buying and holding in a passive way. In the example, the investor would have bought at the begging of the period considered, left the investment running without any intervention, and then sold at the end of the period to make the capital gain. If we had to take a closer look at the ten year chart however it is clear to see that there were opportunities to make more than 66% by for example shorting the same S&P 500 between 2007 and the first quarter of 2009, by going long again from 2009 to the first quarter of 2010 and selling off again.

This method of investing is called active management where an investor would try to anticipate market movements and earn returns above the market rate. Of course, we have the benefit of hindsight in our simple example so it would not be that easy to outperform the market. However, there are methods that exist that attempt to analyse the past patterns and directions of equities with the aim of anticipating future movements. Technical analysis is all about building models and trading rules based on observed price and volume changes. Back testing is regarded by many as highly relevant to creating models and algorithms that can trade equities in a long term profitable manner and in fact outperform the market.

The Bottom Line

The aim of this post was to give a general introduction to equity investing. Locally, many investors tend to shy away from equities and they prefer fixed income investments such as bonds and bond fund since they pay more reliable regular income. However, given the interest rate scenario, which I have made reference to quite a lot in my previous posts, one has to be careful of the interest rate risk present in bonds and bond funds. Adding an element of equity investment to a portfolio could help mitigate the interest rate risk and diversify one’s portfolio to be positioned better for the months and years to come. There are different ways of investing into equities and I will be uploading more posts in the coming year which discuss such methods. One of the most advanced methods of investing into equities is through algorithmic trading. Anyone wishing to read more about this method should see my previous post here.

As usual, please refer to the normal disclaimer.


Algorithmic Systems Trading – The Modern way of Trading

Algorithmic Systems Trading is sometimes confused with some impossible to understand formula that is too complicate to trust. In reality it is just a fancy way of describing the combination of trading using the advantages of computers, mathematics and statistics. It is a scientific approach to investing based on technical analysis and is typically characterised by many trades held for short periods of a few days. Thus, using what is called the law of large numbers, enough wining trades will end up outweighing the losing trades leading to a positive return for investors.

Is this high level of trading available to everyone?

An initial concern investors may have is that this type of high-end investing would only be available to high net worth clients having millions to invest. In reality companies like Novofina which are so called FinTech (Financial Technology) and WealthTech (Wealth Management through Technology) companies make this type of investing available to investors willing to allocate at least €30,000. These sort of companies are bringing high-end investing previously reserved just for elite clients to the retail space.

Novofina, which is licensed by the Malta Financial Services Authority, applies algorithmic systems trading to investing in US large capital stocks, the so called blue chip companies. These are the largest companies quoted on the US stock markets, companies like Amazon, McDonalds, Apple, Exxon Mobil and the like. The company combines different systems that trade based on different criteria such as stochastic systems, Bollinger bands and other technical analysis schools. It combines these different strategies to make up its two main products which clients can invest into. So as opposed to trying to invest on their own based on some gut feeling or long term expectation that may never come to fruition clients get access to cutting-edge computer based equity selection. Best of all the systems operate on their own without the need for client intervention except to decide on how much to invest and what level of risk they are prepared to take on.

Is this a get rich quick scheme?!

Definitely not. Investing in shares has historically been the best form of investment time and time again. However, it is still a long term investment for clients having a minimum 5-year investment horizon. Looking at the returns on equities versus bonds (gilts) versus retail prices between 1899 and 2011 (thus including the great depression, the world war periods and the 2007/09 financial crisis), as reported by Barclays Bank, it is clear how much better off equity investments are over the long term:

By investing smartly into the equity market using such systems employed by Novofina you will not turn €50,000 into €500,000 within a year. That sort of return is not sustainable and would be too risky to attempt to achieve in a short period of time. Nonetheless, turning €50,000 into €500,000 over a ten year period for example is very much possible. This is particularly interesting given the current interest rate scenario whereby we are finally starting to see central banks increase interest rates following a prolonged period of virtually 0% rates. Keeping in mind that prices of bonds move inversely to interest rates, should there be an indication that the European Central Bank could be increasing its base rate all local bonds (especially the longer dates ones) would suffer a fall in price. We have already started to see some “risk-on” movement with the prices of Government Bonds across the EU countries falling in price. This appears to be happening due to an improved appetite for risk whereby investors are selling their government bonds and opting for investments that are perceived to be riskier, such as shares.

Therefore, considering a shift into an equity based investment such as the algorithmic systems based products mentioned in this post could prove to be a well-timed investment decision. Adding equities to one’s portfolio has been proven historically to offer a better balance and overall higher average return. By doing it wisely, using statistically proven methods which are objective as opposed to a human traders’ subjective tendencies, one has a better chance of managing the downside and benefitting from the upside.

The Bottom Line

Algorithmic systems trading is nothing to fear and is based totally on statistical real returns. It is considered by many to be the best investment method available since it uses the latest stock-selection methods which consider many important characteristics of trading successfully such as entry points, profit targets, maximum holding periods and batch sizes. Combining all this and achieving lower risk through diversification of the investment portfolio should prove to be a long term winning formula for any investor. Best of all, such products are already available locally through Novofina starting from a low minimum investment of €30,000.

* This post was issued by Kyle Debono, Managing Director and Portfolio Manager at Novofina Ltd. The information, views and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice. Novofina Ltd has not verified and consequently neither warrants the accuracy nor the veracity of any information, views or opinions appearing on this link. Please refer to usual general disclaimer here.

Foreign Exchange Risk: Your risk.


We live in a financial world full of risks. The most common types of risks that we normally take note of are default risk, credit risk, interest rate risk, liquidity risk, third party risk etc. However, most investors tend to take foreign exchange risk for granted, perhaps because this could be an indirect risk.

Foreign exchange takes place when you or your investment deal in another foreign currency which is not your investment’s base currency, or your country’s base currency. For example, if you are buying a UK Growth Fund, which is denominated in Pound Sterling, you will automatically enter into an exchange rate risk. Why? Let us assume that you invested GBP10,000 in this UK Growth fund on the 1st of June 2016. The European Central Bank (ECB) market rate was at 0.7736. In reality, when you are going to exchange funds from one currency to another, you will be charged a ‘margin/markup’ from your exchange rate provider or bank. The amount of profit the bank will make would vary, normally depending on the amount of the transaction and the expected amount you transact in a year. For retail investors or households, this rate would not be the most exciting thing you have ever seen. On average, the rate will be ‘loaded’ by around 2%. This means that you would be paying an extra 2% ‘hidden cost’ when exchanging your funds from EUR to GBP. Taking this assumption, you would have used the rate of around 0.7580. This means that you would have been required to pay EUR13,192 to get GBP10,000 on the 1st of June 2016.

Around 5 months have passed and we are going to assume that your investment was stable and you have made no losses or profits on the value of shares/units in GBP. However, you realised that the exchange rate today is 0.8866. When you checked with your bank to exchange GBP to EUR, the bank or broker would add another 2% to your exchange rate as a ‘margin/markup’ which would cover the broker’s fees. This would provide an exchange rate of around 0.9045. Hence, if you would like to convert your GBP back to EUR at the rate of 0.9045, you would get around EUR11,055. This would have resulted in a loss of EUR2137 (or 16% on your original investment) in just 5 months based solely on the exchange rate movement.

The above was given as an example to help investors realise the extent of the risk one is taking when entering into foreign currency exposures. Such exposures can be hedged (or covered), however, these are very difficult to be managed for retail investors. The main ways to hedge an FX (Foreign Exchange) exposure are by either opening an exact opposite trade on the market, by locking in a rate on the forward market, by an FX Option or by a Swap agreement. The first two are very common especially for small businesses while the latter two are more common for those large or medium institutions which have an ongoing exposure to foreign exchange.

You may also have an exposure in foreign exchange without being aware of. For example, let us take a UK Growth Fund example again. However, this time, the UK Growth Fund is being offered to you in EUR. Therefore, you will be buying the fund in EUR and you will have no apparent FX Risk. However, when one looks deeper into the matter, one would realise that the fund itself is exposed to FX risk since the manager invests in stocks that are priced in GBP. Thus, it would be a decision of the fund manager or Board of Directors to decide how such a risk is managed. In such a case you will have an indirect FX Risk. Thus, taking the same scenario above, if the fund did not hedge the FX exposure, you would have probably seen a depreciation in the fund’s price in EUR terms. In such a case it would be strongly recommend that the investor read through the Prospectus of the fund and identify the risk management policies of the fund when it comes to FX risk management. If such a policy does not exist, then such a risk must be taken in consideration before an investment decision is made.

How and why are foreign currency rates affected?

There are three main ways of how foreign exchange rates are affected. The first and most common one is through fundamentals. This means, that if the UK economy strengthens and that of the EU weakens, then the value of the Pound would usually rise against the value of the EUR. There is also the case of ‘expectations’ vs ‘reality’. You may have a situation where, for example, you have positive news from the UK and still see the Pound lose value. The reason is that the market could have expected a ‘better’ result even though the result in itself was positive. For example, unemployment rates were published by the UK and these indicated a fall in unemployment. The news by itself is positive. However, the market was expecting the unemployment rate to be even lower than that published. In a highly liquid and transparent market such as the FX market, expectations are also factored/priced in the FX Rate before the actual result is published. Hence, when expectations differ from the real result, one would expect an adjustment in the rate accordingly.

The second way how rates are affected is through speculation.  Speculators would be taking ‘bets’ that a rate would go up or down. Such bets can be aggressive which may affect the rate itself and/or create an influence which would lead to more speculators betting in the same direction making the rate move. The forex market is a large market and in fact trades over US$5 Trillion a day! It is difficult for a single broker or speculator to make an effect on the market on its own. However, a combined effort would have its effects. There is also the issue of a ‘self-fulfilling prophecy’. If everyone thinks the rate will go down if it hits a particular rate level, then everyone would be making bets based on this expectation. This would create a self-fulfilling prophecy and the market would move accordingly. However, one should note that speculation usually affects the market in the short term and it would be fundamentals that would work in the long term.

The third way how foreign currency may be affected is through government intervention. Such intervention is very rare as it may create trust issues when it takes place or other economic effects which may not be desirable. A particular government may use monetary policy to control the value of the country’s currency. This is more easily done when the currency is of a single country. For example, it would be very difficult to see a government intervention from the EU towards the Euro as all countries would need to support such a decision. However, it would be relatively simple for the UK, for example, to impose or use such monetary policy. For instance, the Bank of England may decide to print a lot of Pounds and increase the money supply which would result in devaluation of the Pound. The Bank of England may also buy excess Euro to keep the Pound stable at a particular level. This is normally done to ensure competitiveness in the UK when compared to other markets. This was done in 2011 by the Swiss National Bank (SNB). The SNB at that time guaranteed a rate of 1.20 against the EUR by purchasing excess Euro on the market. However, in early 2015 the SNB decided to discontinue this without warning and the EUR/CHF crashed by over 20% instantly creating panic in the market. This is why government intervention is very rare and it is avoided unless there is a clear requirement from the government to step in and safeguard the country’s interests.

What does a Brexit mean for the Pound?

This is a tricky question as there are far many uncertainties on the future of Britain and how the economy is going to be effected. The market is currently reacting as follows: if the UK exits the EU, then the Pound would lose value, if not, then the Pound would gain. The main probable reason for this is due to the expected taxes that the UK would probably have to pay when dealing with the EU. This would make UK products less competitive in Euro terms when dealing with other EU products as these would be loaded by say 15% tax or so. Hence, for the UK to compete in such a market after being taxed, the GBP would need to lose value to make up for the increase in price due to taxation. However, the biggest issue of such a currency devaluation would be that as it helps exporters to maintain their competitiveness, it would make things difficult for importers as they lose purchasing power when importing goods from the EU and paying in Euro. This is because they would need to fork out more Pounds for the same amount of Euro they would have paid a few months back.

The Bottom Line

Thus, to conclude, for retail investors, ideally one should avoid FX risk. The market is very large and unless you cannot avoid such a risk, then it would probably pay if you just avoid it by sticking to your home currency when investing. For institutions, hedging such an FX risk is important. One should remember that a company is not there to make profit from FX. The importance here is managing your losses and removing uncertainty due to changes in currency valuation. This could simply be done by a forward contract or through innovative FX Options products which are available on the market.

As always this post is for information purposes only and does not constitute any form of advice – the general disclaimer should be kept in mind.

About the Author

This has been a guest post prepared by Mr. John Caruana. John holds an M.Sc in Banking and Finance (University of Malta) and has been working in the local financial services industry for the last 8 years in various roles from investment advisor to ForEx trader. He is currently the managing director, compliance and MLRO of a locally listed investment services company and sits on the Board of various funds.

The Local Bond Market and the Interest Rate Game

percent blocks

The fact that interest rates are at an all-time low, especially in the short history of the local bond market, is known to all investors. Given such a scenario, the following question are interesting to consider:

  • Are all investors factoring in the possibility that interest rates could go up?
  • Are they factoring in the situation that they could be stuck with a lower yield than what they could get on the market once interest rates did in fact go up?
  • Are they appreciating the fact that if interest rates go up the companies borrowing at the low rates might not afford to refinance their bonds at a higher rate?
  • Are the low interest rates and such high demand for any return attracting the wrong bond issuers?

The post will expand on the above questions and other related issues focusing around the local bond market, low interest rates and the high demand for interest paying investments.

The Local Government Bond Market

Following the latest movement of falling interest rates that begun in the aftermath of the 2007-09 financial crisis we have seen the local government issue bonds that are longer dated and have lower interest rates than ever before. These two factors increase the interest rate risk of holding such bonds. But with not many alternatives around the demand for Malta Government Stocks (MGSs) has been consistently strong.

Looking at the yield to maturity (YTM) on the MGSs one would see that it is less than 1% for all bonds with a maturity until 2028. Furthermore, the YTM on the MGSs beyond 2028 goes up to a maximum of just 1.88% which is for a bond maturing in 2041[1]. What this effectively means is that the Maltese government can borrow for a period of over 25 years at a cost of less than 1.9%. The major risk here is that within a period of 25 years a lot can happen, including an increase in interest rates.

Let us take a scenario where interest rates went up by 2% in 10 years’ time and use the 2.40% MGS 2041 as an example. So in 10 years’ time the maturity of the bond would be 15 years away. The current YTM on a 15 year MGS is around 1.15% when the base rate (as determined by the European Central Bank and upon which all other interest rates are calculated) is 0%. So if the base rate had to go up to 2% in 10 years’ time we can assume that the YTM on a 15 year MGS should be around 3.15% (i.e. 2% higher). For the 2.4% MGS 2041 to be yielding round 3.15% in 10 years’ time its price has to go down to around €91 per 100, which is almost 18% lower than the current price.

Of course the above is just assuming that interest rates go up by 2% in 10 years’ time, this could be argued to be a conservative approach. So what would the situation be if interest rates went up by 2% in 5 years’ time instead of 10 years’ time? The price of the 2.4% MGS 2041 would go down to around €80 per 100, representing a fall of around 27% from the current price.

Bond YTM

The Local Corporate Bond Market

Corporate bonds are bonds issued by companies, so on the local bond market it includes any bond that is not an MGS basically. In this area we have also seen a predicted move toward issues of lower interest coupons and the maturities have more or less been at a standard of 10 years. It is much less easy to compare different corporate bonds than it is to compare different MGSs. This is so since different entities will have different risk factors, while MGSs are all issued by the same government of Malta.

So not every issuer is as safe as the rest, for example an issuer who has just one project in Libya is considered much riskier than an issuer that has a diversified portfolio of assets that generate income streams from different markets. The problem is made much worse when interest rates are so low that many issuers are attracted to the market and demand is so high for any interest yield that almost every issue gets over-subscribed.

Such a scenario could create a very devastating outcome when all issuers are able to borrow at below risk-adjusted rates in the current market. The risk here is that if interest rates had to go up by the time such issues mature the company might not be able to re-finance its bond at a rate its cash flows could afford. So for example, we have the upcoming Premier Capital bond maturing which will be rolled over. In the company announcement it was stated that €24.6mln of the old bond will be exchanged for €65mln of a new bond. Assuming the usual 10 year bond maturity is chosen and considering the YTM on the currently existing corporate bonds, it is not difficult to assume that the coupon interest rate on the new bond will be below 4%. One can argue that since the coupon is so much lower the company can afford to actually borrow more (the old bond had an interest rate of 6.8%). This is all well and good, but €65mln is considerably more than €24mln so the interest expense will definitely be higher.

The point I am trying to make is the potential problem that could exist in 10 years’ time when this new bond matures. What would happen if interest rates had to go back up to what they were 10 years ago when the initial bond was issued – would the company afford to refinance such a large amount of borrowing at a higher interest rate? Would investors panic if interest rates go up by 2% in 5 years’ time and the price of the bond would fall to the lower €90s per 100?

I have used the Premier Capital bond just as an example since it is the latest issue to be coming to the market. This is not the riskiest bond issue on the market which actually makes the whole situation worse. In reality there are many other bonds that could suffer the same fate if interest rates had to go up. So what could result would be a simultaneous fall in price of local bonds. Imagine a situation of many bonds on the market falling towards the mid to lower €90s per 100 meaning that investors would be down say 7-10% from the current prices of their bonds. Would we have a situation of a rush to sell such bonds? Considering the fact that such bonds could get very illiquid very fast the prices could go well below the theoretical prices I am assuming here. To make matters worse funds and other investment vehicles that invest into the local bond market which may hold large amounts of the issued bonds could be making the whole situation even worse. If faced with a lot of redemptions at once due to the potential quick fall in the price of these funds an even worse fire-sale situation could ensue.

The Bottom Line

In conclusion it must be stated that the above is all based on assumptions that interest rates go up within the medium to long term. This can very well be the case, but we could also have a prolonged period of low interest rates. In reality it is anyone’s guess and no economic model can accurately predict the reality we will experience. The key to lower one’s risk is to stick to the safer bonds with the shortest maturities and to diversify the portfolio as much as possible. Such a scenario is not favourable to the buy-and-hold investor who would buy a bond with the intention of holding it until maturity. Thus it would make sense to take profits when prices have risen to a decent amount and crystallise such profits by actually selling the position. By doing so and reinvesting into new issues on a regular basis an investor could lower the risks I have focused on here, but they would not be eliminating them. As usual, please refer to a professional investment advisor before taking any investment decision and the usual risk warning applies that nothing presented here is actually investment advice.


[1] Figures are as at 21st October 2016

Non-Performing Loans – an EU perspective


The bread and butter of a traditional bank is the provision of loans. Although banks have reduced their dependency on this main source of income by branching out into other fields of the financial services world, the creation of loans is still a very important economic service. These loans are granted to households, business and to other banks, can be short or long term in nature, having a fixed, flexible or no interest rate and will be subject to different assurances such as collateral.

What is common between all loans is that they all carry a risk – the most basic of which is the risk that the loans become bad-debts or non-performing because the person or entity that took the loan can no longer service it. Non-performing loans will always be a problem for all banks since no model can ever cover all the risk involved and from time to time some borrowers will inevitably be faced with situations that were thought unlikely to happen.

From a regulatory point of view, a loan becomes a non-performing loan once more than 90 days elapse without the borrower paying the agreed instalments. Sometimes the banks can manage to agree new terms with such borrowers but at other times the bank would simply have to write off the loans and try to collect on the collateral and guarantees it would have secured before granting the loan. Banks also have the option of selling off the loans, but this will be at a discount and is dependent on finding someone to take on that debt.

What is the cost of non-performing loans?

It should be kept in mind that the cost of non-performing loans is a direct burden on the bank but an indirect burden on potential borrowers. As a bank is faced with more and more non-performing loans it would inevitably have to tighten credit and thus lend out less money. It must do this since its profits will start getting eaten away by the cost of managing the non-performing loans. Although loans are an asset for a bank they also come at a cost. The cost is not just the opportunity cost of using the same money for a different venture, but also the regulatory cost of keeping the loan on its books.

Therefore, as the number of non-performing loans rises the greater economy will suffer as loans become more expensive and less available. The expense could be in the form of higher interest rates, higher requirements for collateral and more stringent terms for the borrowers. As these factors come into play it would automatically become more difficult to obtain credit from a bank and thus some people and entities will be rejected for a loan. As credit becomes more difficult to obtain businesses will invest less and private individuals will take on less projects. So the effect on the whole economy is multiplied since less work is generated.

How do EU countries compare on Non-Performing Loans?

The below chart depicts the amount of non-performing loans as a percentage of total loans for the EU countries as at March 2016:

As expected the countries with the biggest economic problems have the highest percentage of non-performing loans. Countries like Cyprus which experienced a banking sector crises in 2012/13 and the so called PIIGS (Portugal, Ireland, Italy, Greece & Spain).

If we focus on the worst two countries (Greece and Cyprus) we can see that almost half the loans that have been issued are not being serviced. This of course is a very worrying situation for these two countries which is very difficult to get out of. These two countries are quite apart from the rest of the pack with the next worst country having a percentage of around 20%, which is still worrying. Ireland has started to improve as an economy but the percentage of non-performing loans is still quite high at around 15%. Having said that, the figure has gone down from the 20% registered in September 2015. Malta is sitting around mid-table, however it is worrying to see that over a period of 6 months the figure went up from 3.7% to 6.8%.

The below figure shows the same rates 6 months earlier as at September 2015:


The Bottom Line

Non-Performing loans are an indicator of economic health. The higher the percentage of such loans to total loans the more difficult and more expensive it is to obtain loans. This has a ripple effect on the economy as less investment and private consumption is registered. This is why the regulators place great emphasis on the measurement and management of these loans. Supervisors monitor the overall level of non-performing loans across euro area banks. They also check whether individual banks adequately manage the riskiness of their loans and if they have appropriate strategies, governance structures and processes in place. This is part of the common supervisory review and evaluation process (SREP) that is carried out for each significant bank every year. Furthermore, the European Central Bank regularly carries out coordinated exercises to review the asset quality of the banks it directly supervises.


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