Value Partners - Making It Work in China and Asia 20101021

8/3/2019 Value Partners - Making It Work in China and Asia 20101021

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w w w . v a l u e p a r t n e r s . c o m . h k

Value Partners Limited9th Floor, Nexxus Building41 Connaught Road Central, Hong KongTel: (852) 2880 9263 Fax: (852) 2564 8487Email: [email protected]

A Presentation by

Mr. Cheah Cheng Hye

Chairman and Co-Chief InvestmentOfficer, Value Partners Ltd.

Organized by

Columbia Business School'sHeilbrunn Center

of Graham & Dodd Investing

21 October 2010

Professor Bruce C. N.

Greenwald

Robert Heilbrunn

Professorship of Finance

and Asset Management

at Columbia Business

School.

Unfortunately, Dean Hubbard could not be heretoday, so I am on this platform without a leash,

and I intend to make the most of it. So, the moretime you can give me, the more grateful I will be.

All right, if you have read your programs,you will see that this is now the 20th version ofthis breakfast. I would like to see a show of hands how many people were actually here at the first[Graham & Dodd Breakfast] in the broom closet atthe Intercontinental Hotel? Okay, well, it has beenan extraordinary development over that period,and there are people who are due credit for theexpansion to the extraordinary group that you see

here today. So, first I would like to acknowledgeHelene and Sid Lerner, whose family actuallymade the Graham & Dodd Center possible, whichof course runs this breakfast.

Bob Bruce, who is unfortunately not here,who funded the first breakfast, Mario Gabelli andGAMCO, who are responsible for the originalinternationalization of this event, who are fundingand have continued to arrange the simulcast of thisevent to London, and obviously to Fidelity, whoare providing their offices in London. I think it is

being transmitted also to Hong Kong this time insome form, at the behest of the EMBA-Globalprogram in Hong Kong, which is a collaborationof Columbia Business School, London BusinessSchool, and the University of Hong Kong, all ofwhich 20 years ago was completely inconceivable.We are obviously extraordinarily grateful to ValuePartners Ltd., for making Mr. Cheah available onthis occasion, but, I think, most of all, I would liketo acknowledge all the people in this room whorepresent what is increasingly a vibrant and

Value Investing - Making it work in China and Asia

This document is issued by Value Partners Limited for information purposes only. Neither Value PartnersLimited nor the Directors of the company accept any responsibility whatsoever for the accuracy orcompleteness of the information contained in this document.

This document should not be copied or distributed to third parties without the written consent of Value

Partners Limited. This document does not constitute a prospectus, an offer or an invitation to subscribe any securities, or a

recommendation in relation to any securities.


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valuable community of value investors, as thename implies. So, thank you all for being here andfor your long-term support, and I look forward to

the 40th of these to occupy the whole of this hotel.

There have in the past year also been some fairlymonumental changes at the Graham & DoddCenter at Columbia University. One in particular Iwould like to acknowledge on this occasion. ErinBellissimo, after eight years and an extraordinarydegree of productivity that not only involvestaking programs at Columbia Business School andout of the Heilbrunn Center from nothing to whatyou see today, but who also produced fourchildren in that time, is leaving, I think, right afterthis breakfast. So, first of all, I would like to get a

round of thanks to Erin for all her efforts. I mean,Erin stand up, they wont notice, but you shouldanyway.

We are very lucky to have the Louisa Serene,who has so far in the last six months proved to bean extraordinarily able replacement for Erin andwill carry on that work. Louisa, if youll stand up,that would be good, too.

Before I start to do the substantive introduction totodays breakfast, let me just talk a little bit aboutprocedure. Im going to do an introduction that Ihope will only take up all the rest of the 10

minutes I have. Then, I am going to turn it over toMr. Cheah who has prepared remarks that shouldrun some 45 minutes to nine oclock. Then, wewill take questions from the floor. If youreworried, I actually have a couple of questions tostart with, but you should feel free to ask yourquestions at the end of his prepared remarks.

All right, with that as housekeeping, thedevelopments of the last three years have had anextraordinary impact. I think it is clear forinvestors, in particular, on attitudes towardsmacroeconomic factors. When we started this

breakfast 20 years ago, if you mentioned the wordmacroeconomics, people would act as if you hadtransgressed some of the deepest taboos of theprofession. As we stand or sit here today, almosteverybody is suddenly a macroeconomist in somedegree. The success of some investors inanticipating, and, in many cases, profiting fromthe severe economic declines in 2008 and 2009,has obviously led a lot of people to think about the

extent to which they can anticipate similar marketdevelopments.

There has, I think its fair tosay, been an extraordinary

amount of excitement aboutthe former economies, for

good or ill.

One aspect of this focus on relatively high-levelphenomena has been that people have begun tolook around and remark on the extraordinarydifferences in economic performance both pre-crisis and post-crisis around the world. Inparticular, the differences between the rates ofgrowth in emerging markets Brazil, India,Russia, and the other resource exporters and Chinaon the one hand, and the traditional developedindustrial economies of Europe, the U.S., andJapan on the other. There has, I think its fair tosay, been an extraordinary amount of excitementabout the former economies, for good or ill.

I think it is important in this process oflooking at macro forces, to look at differenteconomic contexts around the globe and not losesight of fundamental value principles. And there Iwould start with Warren Buffetts two rules ofinvesting: rule #1 is dont lose money; and rule #2is dont forget rule #1.

First and foremost, I think value investing isabout avoiding permanent impairment of capital.That means preeminently, I think, no bubbles not Japan in 1989, not tech and telecom stocks in1999, and not housing and financial stocks in2008. The problem of course with that prescriptionis in recognizing when you are in the middle of abubble. There are, I think, well establishedsymptoms that we can look at. First, all thesebubbles are associated with an extraordinarydegree of enthusiasm and certainty about the

prospects of a particular asset class or a particulargroup of stocks or the prospects for a particularcountry. The problem is that sometimes thisenthusiasm is justified.

I think the second and more reliable measureis when you are in the middle of these bubbles. Iwould have to say what I think is the most likelybubble out there at the moment is US treasuries;the returns that are available from the favoredsecurities are disproportionately less than


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comparable returns, or in many cases, less riskyreturns that are available on other securities. So,for example, you can get 2.5% on treasuries today,

because we are in uncharted macroeconomicterritory (at least, with a substantial possibility ofinflation undermining the value of thatinvestment.)

Treasuries are not risk-free, I think, in thepresent environment. At the same time, there areextraordinary franchise businesses that are sellingwith 3% or more dividends with earnings returnsthat are very stable of 5-8% that are notsusceptible to the ravages of inflation, becausethey have pricing power and are able to pass alongincreases in costs that are not particularlysusceptible to deflation, because, by their nature,

they are insulated against competition. And, ifthere is any growth, you are looking in theselower-risk opportunities at returns of 8-11%,versus the 2.5% that is available on treasuries.

How that is going to play outand what that is likely to mean

for profits, I think nobody

without long-term substantialexpertise in China is going to be

able to discern particularly

effectively.

The problem is that in the case of the emergingeconomies, trying to do similar calculations is byno means an easy task. And there, I think, youhave got to rely on the second fundamental Buffettprinciple, which is: know what you are buying;understand where your margin of safety is comingfrom.

What that means is coming to terms with thehelp of experts in these areas and in the nature ofthese economies. China, in particular, is okay. I donot know if any of you have tried to look at the

national-income statistics from China. The lastthat are available on the official website that Ilooked at are from 2005, and they are prettyrudimentary. Also, at the national level, what theytell you about that economy is that it is aneconomy of a kind we have never seen before.

In a typical developed economy, or even inmost developing economies, wages account forroughly two-thirds or slightly more, of nationalincome. If you [can believe it], wages in China

account for less than 40% of national income.How that is going to play out and what that islikely to mean for profits, I think nobody without

long-term substantial expertise in China is goingto be able to discern particularly effectively.At the level of firms, there are accounting

differences, and in China and also in many otheremerging markets, there is a degree of governmentinvolvement and involvement of state-runenterprises in those economies that isunprecedented. We dont have a lot of experienceabout economies that evolve over time towardshigher-end products, and how those state-runenterprises are likely to adapt. Accounting,reporting, and financing requirements in suchenvironments are just very different from what we

are used to.On the other hand, whether it is WarrenBuffett and Charlie Munger with their investmentin BYD on the long side, or Jim Chanos with hiseffective commitment on the short side, people aregoing to engage in the investment climate andwith the investment possibilities in China. Underthose circumstances, it seems to me the best wecan do is provide a reliable guide as a startingpoint with that engagement, and we are thereforeextraordinarily privileged today to have CheahCheng Hye as our speaker, who is I think it isfair to say over the last 20 years, the preeminent

value investor in China, and in Asia, moregenerally.

He is the chairman, co-founder and co-chiefinvestment officer of Value Partners, whichmanages $6 billion. If you read the press, this isparticularly appropriate since Mr. Cheah beganlife as a reporter, which means there is hope foreverybody, no matter where they start. ValuePartners has been widely recognized in the pressnot only for being the leading value practitioner inChina and Asia, but also for being one of the verybest investors and most highly regarded investors.Since China is not notable sympathetic to a value

approach, it is a true testimony to the value of hisadvice. So, it is a great honor to present Mr. CheahCheng Hye.


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Mr. Cheah Cheng

HyeChairman and Co-

Chief Investment

Officer, Value

Partners Ltd.

Thank you very much, Professor.Professor Bruce Greenwald, I appreciate the

opportunity to speak today. I want to say thankyou again to the Heilbrunn Center for Graham &Dodd Investing and Columbia Business School,and of course I am deeply grateful to all of you for

coming. I will try my best to share with you what Iknow about how to apply the value investingdiscipline in my part of the world, East andSoutheast Asia.

Now, before I go on, I need to tell you,according to Compliance regulations, that thestatements that I am about to make to yourepresent my personal opinions and not those ofValue Partners.

As for Value Partners, we are the only listed assetmanagement company in Asia, outside Japan, andeven in Japan there is only one listed company, so

there is ample documentation available on who weare and what we do; there is a lot of transparency.

The company was listed in 2007 by MorganStanley and JP Morgan. The mission of thecompany is very straightforward. Our mission is tobuild a temple of value investing for East andSoutheast Asia. This phrase was coined by yourstruly. Actually, I used to be a journalist; I workedfor The Wall Street Journal in the 1980s. Butseriously, what we are really trying to say withthis phrase is that we are first and foremost a valueinvestor, and only secondly are we a Chinainvestor. The distinction is quite important,

because up to now, China has been what I call astory market. A lot of people buy and sell Chinabased on stories they read in the press or on whatsomebody has told them about. In the process, itcan be very difficult to carry out fundamentalvalue investing according to the textbookdefinition.

So, we are trying to go the other way. Ourstandard textbook throughout the 1990s wasGraham & Dodds Security Analysis. We actually

applied it quite religiously; we used to call it theBible. But in more recent years we switched to adifferent book. I am not plugging the book, just

telling you what we do. It is a book by a guynamed Martin Fridson, whom I never met, calledFinancial Statement Analysis. It is a simpler book,but pretty much the same thing as SecurityAnalysis.

Weve conducted about 2500company visits per year,

excluding phone calls. That isthe real source of our power;

just old fashioned kicking thetires.

So, we do a lot of financial modeling. Weveconducted about 2500 company visits per year,excluding phone calls. That is the real source ofour power; just old fashioned kicking the tires.What we are good at is that we put into practicethe theory of value investing that my colleaguesand I have read about and weve study veryseriously.

I actually do not believe we have anythingoriginal to say about the theory, but I think wehave gained some valuable insights that I will

share with you about its actual application; this iswhat we are actually good at. Now, before I go onto the next slide, I want to tell you that by theroughly mid-to-late 1990s, I was coming upagainst the big what if question, as I tried tocreate a sustainable business model out of theconcept that I wanted to carry out value investingin this very immature market that we call China.Because I began to ask myself what if we cancreate a business model a value investing firm that performs, but that is not dependent on havinga genius or a star performer or some kind of amagical black box within the firm?

I even began to wonder if there was some kindof a conspiracy, maybe by the marketing people orthe press, to try to tell the story that to beat themarket you needed to have a genius or a starperformer or a black box, and I thought to myselfthat this was not a very sustainable way of doingthe job. So, I began to ask myself verystraightforward questions like, is there a way thatnormal people, ordinary people that you recruitout of college, can become very good valueinvestors, at least with respect to the China region?


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So, that became a kind of quest for me. Initially, itwas just intellectual, but as I am going to explainto you over the next 15 minutes, we turned it into

a reality.First of all, you have got to understand that ifyou do not have good people you cannot create agood product. So, the first answer to the puzzle orthe question I just raised is to create a very goodcorporate culture. And the second thing we do,which is, I think, a bit more interesting, although Iknow that sometimes when I say this, I am greetedwith a bit of hostility from people who do notwant to hear about this. I believe I have succeeded,to some extent anyway, in industrializing the valueinvesting process, transforming it from a boutiquecraft into a process of mass manufacture. It sounds

pretty elaborate, but actually is very simple.Again, I will explain to you, but I am trying toget away from a system that relies on geniuses,and trying to get a system that I turned into asustainable and a scalable process. In fact, wehave been doing this in Hong Kong since the late1990s sometimes with great difficulty.Sometimes, we thought better to just give up, butwe stuck to it and we have in the process created,what I think, is a pretty valuable business that infact has consistently been able to beat the market.

I believe I have succeeded, tosome extent anyway, inindustrializing the value

investing process,transforming it from a

boutique craft into a process

of mass manufacture. Itsounds pretty elaborate, but

actually is very simple.

The first part of what we do is that we had to start

from almost ground zero in terms of creating anappropriate culture to implement and execute thisconcept. Here, I have to take two steps backwardsand explain to you the context in which I operate,because here I am in a market that, unlike in theUnited States, is a very young and immaturemarket. The first companies from Mainland Chinawere only listed in 1991 or 1990, I cannotremember; there is a company called BrillianceChina, and it was listed in New York with the help

of Merrill Lynch. That was the first mainlandChina company. Today, of course, it is the partnerof BMW in China.

Things happened at Value Partners tooquickly; there was not enough time to put togetheran in-depth and appropriate culture of professionalintegrity. That is why you sometimes hear somegreat horror stories. Very basic concepts thatshould have been instilled in the market whenpeople first joined, concepts like put a clientsinterests first, be transparent in your dealings,identify and be wary of potential conflicts ofinterest You would be amazed by how manypeople in my industry, in my part of the world,have never heard about it or only pay lip service toit.

So the first thing I did was actually not thefirst, but sometime in the mid-to-late 1990s I puttogether what I callMy Promise, and I asked mystaff to sign it, individually. I framed it and put itin front of them, in front of their computer, so theywould be reminded of it every day. And we do alot of this brainwashing thing, you know, that wehave elaborate ceremonies and kind of assure oneanother that we are very serious about ourPromise.

So, here is a copy of the promise and itbasically just encapsulates basic concepts that youneed, because value investing is really a kind of a

very vigorous philosophy and deep exploration ofreality, but if you dont have people who areintellectually even honest, there is no way you cancarry out the mission.

Now, we then go on to the actual investingprocess. When I talked about using words like


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mass manufacturing and industrializing a craft,what I really meant was that I have broken it downinto a set of skills. Each skill can be mastered by

fairly ordinary people with probably just a collegeeducation, and the process is teachable, isrepeatable, is sustainable, and is scalable. It isdefinitely not magic, it is definitely not driven bygenius, but it is all the above that I mentioned toyou.

I would identify each of these skills to you,but the starting point for this is that there are anumber of images I can draw for you to try tocommunicate what I am actually trying to achieve.

One is, I was very frustrated by the idea thatno matter how smart a human being is even thePresident of the US, for example, who is after all

just a human being his potential for excellence isalmost defined by the limitations of being human.But what I really want, if possible, is an operationor situation that can be almost beyond human superhuman and then I thought of the concept ofthe ant colony.

There is a saying that in case of an all-outnuclear war, the human beings wont survive butthe ants will. Why is that? Each ant is probably apretty dumb animal or insect, but together, bysocializing the process involved in survival andproduction, they are incredibly strong. You cantreally kill them all, they are repeatable, they are

scalable, etcetera.

Each human being has

different strengths andweaknesses, but together we

make a formidable team.

Finally, I thought about what Chairman Mao said,or was alleged to have said. I was too youngactually, but there was something about usingsocialism to help capitalism. So, as a company, weare a pretty socialist company. I wont go into bigdetail, but people have compared us to beingIsraelis on aKibbutz everyone helps each other,but we are actually doing all this in cause of thecapitalist system actually.

Anyway, so what we are really doing is thatwe have broken down each skill into steps andhere are the steps, these are the so-called sevenspecialist skills.

The first skill, obviously, is originating ideas.Original ideas itself is an important skill. We havea matrix, let us call each of it A, B, C, D. Im quite

proud to tell you that I actually scored A inoriginating ideas, but unfortunately, in some otherskills I have like a C.

Each human being has different strengths andweaknesses, but together we make a formidableteam, I think. So, for originating ideas for a valueinvestor in China and Hong Kong, the key is tofind ideas that are very contrarian. Perhaps Ishould illustrate it on the board. I will go througheach skill step by step and tell you or highlight thesalient points that we use to train people for eachskill.

For originating ideas skills, which I claim to

score an A, we have a universe of severalthousand stocks: Taiwan, Mainland China, HongKong, and in the case of Value Partners, someKorea, Japan and Southeast Asia. We simplydivide all the stocks into category 1, 2 and 3.

One is undervalued, so your job if you workfor me or in my team is that you must try toidentify Category 1 stocks and then do research onit. Category 1 stocks are undervalued. Category 2is fair value. We find a lot of sell-side brokers tendto recommend Category 2 stocks.

And, when you sit in a taxi and the taxi drivertells you about stocks, it is probably Category 3.

So, technically, our objective is to buy 1 andsell at Category 2.5. Later I will start telling aboutthe problems, but anyway, right now I am justgiving you the theory. For Category 1, generally,the most fertile area to find these ideas are stocksthat are unpopular that nobody cares about definitely not an index stock, or that somethingbad has happened. It sounds so simple, but in reallife it is quite difficult to do because maybe it isAsian culture or human nature, but people do notfeel safe sticking their necks out to look at theseunpopular companies.

So, in China-related stock markets, there are

actually quite a lot of Category 1 stocks because itis a very emotional market, very momentumdriven, so stocks fall in and they fall out of favorfairly quickly, and, in fact, in a rather predictableway. Now, in case you can identify good Category1 stocks, your next step is to start looking at theresearch part of it. Remember, I said this was skillnumber 2.

Research, now for a firm like Value Partners,and I think a number of firms around the world, is


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quite difficult to push out to the frontierintellectually. We have standardized ourspreadsheet, and we look at all the obvious details

and financial numbers and number crunching. Theonly thing new I can say about research is that inthe China context, we have been movingincreasingly away from quantitative analysis toqualitative analysis. When I first started in the1990s, there were very few companies withsuperior business characteristics in China. Whatyou were really buying were pretty lousycompanies trading at very cheap prices, and that,in fact, it was quite difficult to be a long-terminvestor because some of these companies gotchopped up, or competitors came in and they aregone.

So, we were pretty much a traditional classicvalue investors trying to get the last free puff ofthe cigarette. But in more recent years, the trendhas been much more encouraging. You are findingmore companies that may fit the description of agood franchise. I.e. a sustainable, competitiveadvantage, durable advantage we call it, and to dothat it is very difficult to quantify in numbers.

So, in China-related stockmarkets, there are actually

quite a lot of Category 1

stocks because it is a veryemotional market, very

momentum driven, so stocksfall in and they fall out of

favor fairly quickly.

You have to look at the characteristics of themanagement and the business model. But insummary, we are looking for something called thethree Rs: the Right Business, run by the RightPeople at the Right Price. And as I mentioned

earlier, we are seeing a trend where the originalemphasis of Value Partners on just the RightPrice, because it was the only thing we haventfound, is changing more and more to the RightBusiness run by the Right People.

The third skill was originally not considered askill until I began to realize that decision makingis in fact a teachable skill in itself. Actually, thereal problem is the lack of decision making,because although we had a team of almost 30

people who were analysts and fund managers, fewpeople actually wanted to stick their neck out andmake a real decision.

We call that a lack of killer instinct this isone of my phrases. Nobody really wants to killanybody anymore in our civilized world, youknow. So, we even have a guy who has since leftthe company, we called Mr. OTOH.

OTOH stands for On The Other Hand.Yeah, Im sure all of us know about this, that

the analyst will always give analysis in about 30pages that take you half the night to read, and theconclusion is: however, if, but, and on the otherhand, you know. So, in the end, you dont knowwhat you are supposed to do, if anything.

So, I am trying to kill the Mr. OTOHs in my

company, but it is not easy, and I began to realizethat it is possible to train and be good in decision-making. One clue to the way we are doing it isborrowed from the Buddhist philosophy, which Iam a follower. It is to remove yourself, your senseof self from the equation, when you are trying toanalyze anything. By injecting yourself or yoursense of me into an analysis, you distort thereality because your ego gets involved. Yourperceived self-interest, your need to be givencredit for something, gets involved. So, removeyourself from the analysis.

Now, the next cue, we call it deal

structuring. This again came about almost byaccident, because I began to realize that by localHong Kong standards, we are a very big company.

But anyway, we are a big guy in our littlepatch of the jungle, and we can demand goodtreatment from the brokers, and I began to realizethat if we decide to buy something based on theresearch and our idea finding, we shouldnt just goand try to buy in the stock market. We shouldapproach the company and say, lets make a deal:well buy 5% in your company, and you do itthrough a form of placement of a single block ofshares or what the American people call PIPES

transactions, which I think stands for privatelysomething, something per equity, whatever, youknow.

You always get better terms,more discount, oryou can get them as convertible bonds. For yourinformation, about slightly over a year ago, anAmerican company called Affiliated ManagersGroup, listed in New York City the chairman isover there. They bought 5% of my companythrough a negotiated deal.


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All right, so due structuring in itself justbrings a lot of benefits to clients.

Now, the next skill I think well mention is

Execution. This is no longer done by our fundmanagement team. It is actually done by aspecialized team of full-time dealers; we havethree of them in the office. It is in itself aspecialized task.

Then, from here on my scores are dropping,for your information. I tend to get high scores hereand lower scores as we go along because I getbored as we go down the sausage-makingmachine.

Maintenance this is just a fancy word forsaying, after you buy the stock, dont forgetabout it. Keep in touch with the company, update

your research vigorously, and keep thinking howyou can continue to enhance the value of theinvestment.

And the final thing is Exit. For people like me,Maintenance and Exits are weak points, and I tendto try to delegate it to other members of my teamwho are more interested in these particular skills.Exit means actually selling the stocks, and theprevailing wisdom for this is that you aresupposed to exit when you figure that what youknow about the company and the people in thecompany is quite common knowledge toeverybody, so you have no more value to add to

the investing process.Then you should be getting out; in theory. In

real life, we usually sell far too early. I think it is athing about value investors. We see a lot ofproblems all the time.

I think it is a thing about valueinvestors. We see a lot of

problems all the time.

All right, sorry, just a short intermission. In caseyou are the CIO, you have to master theseadditional skills that I had not mentioned earlier.The additional skills are: providing leadership, tomake things happen macro strategy which wedidnt use to think about as a skill, because wewere diehard, bottom-up value investors, until theAsian financial crisis. And then we realized thatyou actually better have some idea of what is theoverall macro environment you are operating in;asset allocation and portfolio construction. This is

not done at the funds managerial level; it is doneat my level.

I am actually the Co-CIO with another guy

named Mr. Louis So. We two guys are responsiblefor these skills, for better or for worse. We try toprovide leadership to the team, motivating people.Here, the key take-away you should note is thatthere is an abundance of hard skills in Asia, but ashortage of soft skills. What do I mean by that?For your typical Asian people, if you can sit anexamination and provide some text books, theywould do very well; they have that kind of culture.But if you ask them to do things that are not sotangible like communicating with people,motivating people, providing leadership andleading, they are not so good. I am not sure why

that is so, but it is a fact. So, we tend to struggle alittle bit in finding people who are willing to beleaders or to even communicate properly withpeople in the office leadership.

Macro strategy, I am not a macro expert, butbecause of my perhaps size and experience, I amplugged to people who are macro experts, and Imake sure they give me the first call if they thinkanything is worth talking about. That is probablygood enough, but you have to have some sense ofthe environment where you are trying to putmoney to work, although we remain primarily abottom-up stock picking company, and asset

allocation and portfolio construction must takeinto account your evaluation of the macroenvironment.

So, more or less as an example, we went from10% cash in our funds to 1% cash in our fundsbetween June and July this year, because, from amacro point of view, we concluded this is one ofthose windows that opened up for China investingwhere you should be very aggressive when puttingmoney to work.

The right way to go to do our

job is that if you enter atransaction if you are a buyer,

you shouldnt be buying if youthink the seller knows more

than you.

Negative interest rates, soft landing, nowincreasingly evident for the China economy, and


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various other factors, including inflation, are likelyto increase a harder landing because the HongKong dollar and the US dollar are pegged, so we

are importing a lot of loose money policies fromthe US, even though our own economy is actuallydoing very well. So, the adjustment is taking placethrough asset prices.

I want to share with you at this point, thehalfway mark of my prepared remarks, thatinternally we no longer call ourselves valueinvestors, although of course we are, you know,otherwise I dont think I will be invited to speak toyou today. But internally, we use another phrasenow. I wont write it because its easy toremember.

We call ourselves advantage investors,

which is part and parcel of the seven skillsapproach I mentioned to you.I have developed and written quite a number

of memos internally on the concept that the rightway to go to do our job is that if you enter atransaction if you are a buyer, you shouldnt bebuying if you think the seller knows more thanyou.

If you are a seller, you shouldnt be selling ifyou have not clarified why the buyers are willingto buy from you. This is a simple advantage idea;that you must always have some confidence thatyou have an advantage over the counter party in

any transaction, and we have developed manytheories about advantage, most of it is based onthe idea of having more research.

Here we are blessed, because unlike arelatively more efficient market like the US, ourmarkets are extremely inefficient. We have allsorts of people who are not qualified to be in thestock market but who insist on being in it anyway.I had many experiences where I asked people,what is the purpose of the stock market mydear? And they are, Oh! Its there for you tomake money.

That is all they will say. They forget that the

market is there to mobilize surplus savings of asociety and put it to work in productiveenterprises. Nobody cares about that actually;asset-wise, maybe.

But anyway, so if you take the trouble toresearch and do company visits, you have actuallya pretty strong advantage over many other playersin China-related stock markets who are actuallyquite, you will say, uneducated in the true senseof the word.

You definitely can practice advantageinvesting. Portfolio construction at my level ismostly based on the idea of taking advantage of

the macro environment and highlighting your corecompetence. Actually, we only have one real corecompetence: stock picking.

So, the portfolios that I run are all designed to as Professor Greenwald mentioned earlier togather against the downside risks, whileparticipating in the upside through a constructionsystem that basically allows us to shine in the onething we know best: picking stocks.

This process allowed us to growour fund size in a way that

couldnt be done if our businessmodel was based on a single

human being, a certified genius

running the fund.

I am going to go on because it is time to talk aboutoverall things I learned about how to survive andprosper in China-related markets. Here, I amleaving one of my main subjects, which is how Ithink we are trying to industrialize the process ofinvesting, but before I go away from the subject, I

want to emphasize again that when I tried todescribe this process to some clients, I noticed thatthey were not very happy, because they thoughtthis is a some sort of a trick for us to become anasset gatherer, that the reason we have thisindustrialized process was because we want to getbig.

This process allowed us to grow our fund sizein a way that couldnt be done if our businessmodel was based on a single human being, acertified genius running the fund. But here we canhave many, many people are doing it, right?

But I just want to assure you this is really not

true. The truth is, from the 1990s onwards, I wasvery interested in knowing how we can develop asustainable business model for running money,and yet beat the market consistently, and yetdepend on hiring normal people to join ourcompany. Not great people, but just normal peoplewho can, however, become great, and also asystem that we help each other with ourweaknesses, in a very humble and frank manner.

Okay, let us talk about Asia as a whole. Firstof all, I already mentioned it is basically a very


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inefficient market. You dont necessarily makemoney by investing in superior businesses. As Isaid, there is a growing number of such superior

businesses, but it is still much less than inAmerica. You make money by taking money fromstupid people who shouldnt be in the market; thatis the truth about it its changing but its stillthere.

You need to be familiar with the political andsocial context of the investment, not just thefinancials. We have problems sometimes withAsian people who came out of US Universitieswith an MBA or whatever, because we find thatthey are too focused on numbers alone. Actually,there is enormous baggage in Asia regarding itshistory. Some people are very sensitive about

politics and social issues. You have to besympathetic to it. You have to understand whysometimes so-called irrational things are done. Ithink even the Chinese Government, from myfeedback now, is beginning to realize that growthfor the sake of growth is not that ideal.

There are a lot of other things that areimportant, like having a clean environment,reducing the income gap between the rich andpoor, countryside and cities, and not just growthfor the sake of growth, and this is in the samecontext that you must understand what makespeople do what they do. Because of their history,

their social values, etc.One exercise we try to do sometimes with

some success is, we imagine what the newspaperwill say about the company we are investing in,six months from today, 12 months from today, 36months from today.

I think it is probably because of my ownbackground as a newspaperman. It is very usefulwhen you look that way; that you can imagine,close your eyes and imagine, because you will findthat sometimes the outcome for your particularcompany, whether it is a car company or anagricultural company, is driven not just by

numbers, but by government policies andsometimes even by, let us say, the phenomenoncalled El Nino, which is a kind of a temperature,climate thing that is sweeping the Pacific rightnow.

Now, the last one I will say again is somethingthat I noticed. Sometimes, people dont want tohear from me but I have got a secret that I willshare with you. When I first started my job withValue Partners in 1993, I was like every other US-

trained or US-inference fund manager. I believedin having a very concentrated portfolio. I used togo around telling everybody you wont see more

than 40 companies in my fund, these are my highconviction ideas, and I was very proud of it; andthen as the years went by, I began to realize thatour market was really very different from the US,because there are just a lot of crooks out there withvery bad corporate governance, and some of theseguys are very convincing.

I used to go around tellingeverybody you wont see morethan 40 companies in my fund,

these are my high conviction

ideas, and I was very proud of it.

So, your high conviction idea may turn out to beactually your next lament, you know. But youwont know until you wake up the next morningand read about it in the newspaper that yourinvestment, which makes up 5% of yourconcentrated fund, has just evaporated overnight.

It happened to me quite a number of times, soI have many scars with me. So, in the last,especially 10 years, Ive swung to a differentview. For emerging markets such as China, it isbetter to have a very diversified portfolio. Dontput more than say 1 to 2% of your fund in anyparticular idea, because you can then go to sleepmuch better and you can withstand all these nastyaccidents that seem to happen every now and then,no matter how hard you work at it.

So, now we have a portfolio with typicallyover 80 to 110 companies inside. Now, why dontmore fund managers do what I say; its becausethere is a lot of self-interest. Few fund managersdont have the kind of research resources that I do.If you have a research team of maybe 5 people, it

is already quite a feat to have a fund with maybe40 ideas inside; but we have the resources. Wehave 100 companies and we still have theresources to come up with 100 top-notch ideas;and that is what we are doing. Keep it diversified,be able to withstand the unexpected bad guy whosmiles at you, shakes hands with you, and thendisappears with all your money very suddenly,you know.


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As professor Greenwald was saying, it got thedownside risks, you see, not the variation. Keep itdiversified.

Now, the next phenomenon I want to tell youabout is that our industry over there is surroundedby pirates; not Somali pirates. By this, I meanstock promoters whose full-time specialty isgiving you very convincing presentations andgetting you to put money into their projects orcompanies. I am very familiar with thisphenomenon. I have lost some money to theseguys, too.

It partly has to do with what I mentionedearlier, the fact that it is a young market and ittakes time for the proper values and professionalintegrity to develop. So, you have all these well-

dressed young men and women who specialize intalking to fund managers like me. They know thatwe control a lot of money, and unlike banks we donot really have credit evaluation, we just decide.Sometimes, within the same day, we can give youtens of millions of dollars of other peoples moneyto finance your project if your presentation soundsright.

So these days, if someone comes to see mewho has got the right university degrees and attireand speaks like my kind of language and tells whatI want to hear, I am actually very suspicious. Imnot relaxed at all. I now have a history of

preferring people who are pretty rough and ready,and look like they just came out of the shop floor.That is my kind of person now.

I mentioned earlier about abundant hard skills, notmuch soft skills, and here is the other thing aboutour industry. Because of the incredible growth andabundance of wealth created so suddenly in just 20years by the financial industry in East andSoutheast Asia, everybody wants to join in. Evenpeople who are not the least bit interested infinance. This is very unhealthy. It has created aphenomenon that I call the money disease, where

people join because they think they will make a lotof money not because they are interested in ourprofession.

At Value Partners, we usually have aninduction class that within the first 3 months, Iwill personally give you a talk where I try toexplain to you that your name is your brand. Ifyour name is John Smith, then John Smith is yourbrand. It stands for how people will see you in theyears and the decades to come, and you can very

easily spoil it by becoming a victim of the moneydisease, putting money in front of everything else,whereas money in fact should be a byproduct of

professional excellence.If you are very good in what you do, moneywill find you, you dont have to find money. Itreminds me of Sash Spencer.

Okay, I jumped the slide a little bit. So, yourname is your brand. Now, the next thing we wantto do is that we think that the disease of fundmanagement is ego. People who have had somesuccess being money managers, they are veryvulnerable to the ego disease. They think they areGod and we try to discourage that. For example,we have this Master Big Theory of how you seeyourself. If you see yourself as smart, you are

likely to do stupid things. If you see yourself asstupid, you are likely to do smart things.

You can very easily spoil [yourpersonal brand] by becoming a

victim of the money disease,putting money in front of

everything else, whereas moneyin fact should be a byproduct of

professional excellence.

So, we try to tell each other, let us see each otheras stupid people. It is better to assume we arestupid. And we also find, at least for our team,people tend to overreact to almost everything. It isthat kind of office: we are nervous, we are jumpy,there is a very high energy level. The average agein my office is about 30 to 35 years old, lots ofsurplus energy.

So, I had to train people before you evendecide what to do, decide how much you arewilling to invest emotionally, and as a reaction, toany situation. Once you have decided it should be

no reaction, some reaction or a lot of reaction, thendecide the contentsof your reaction; what exactlyand how you want to react. And of course, be acontrarian, as always.

I want to show you how all these years offighting and being hurt and trying to be the best ispossible. My own signature is Learn. I changedmy signature when I was about 25 years old frommy name to Learn, so that I can remind myselfevery day when I sign my name to be humble and


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learn new things, because I think the commitmentof learning is one of the major characteristics of acivilized and responsible human being, whether

you are a fund manager or you are not a fundmanager. But if you are a fund manager, evenmore so.

So, timing is good. Im on track.I just want to end the formal presentations and

invite your questions by summarizing someslogans you will see on the walls at ValuePartners, my office in Hong Kong.

We try to be small enough to be effective, bigenough to be strong.

This is probably the subject of another speech,but essentially, even though we have grown to upto 100 people, I have been trying the various

concepts and theories to divide the theme intosmall boutiques, so that each person working inValue Partners would not have a big companydisease.

He or she is actually working for a smallgroup of only 5 people, and they have to think likea boutique and perform like a boutique. I am stillfacing some difficulties in executing thisconcept Thats for the next speech.

Also, I think I told this earlier that we try tocreate a company where we depend on ordinarypeople and try to turn them into extraordinaryperformers.

Because I think it is not sustainable for abusiness model to depend on the constant inflowof geniuses to join you, and even if they do, they

may not stay for very long.Finally, I started these formal remarks ordiscussion by saying that I dont have much to sayabout theory, but we have gained a lot of insightsinto the practice of value investing. In fact, Iwould end by saying that how you see yourself isvery important, and very often I find that I am myown worst enemy.

My own error rate is about one third aboutone third of everything I do. With hindsight, Iwish I had not done it, but it is done, it is too late.So, the way I see myself and the way my youngpeople who are working with me see themselves is

that we think of ourselves first and foremost assoldiers. You know, we dont wear a uniform, wedont carry a gun, but we act very much like realsoldiers, very disciplined, very committed.

We dont have any breaks, and we know thatwe are engaged in a war that never stops, the warfor performance, and these things are not verytheoretical for us because we actually mean whatwe say.

Thank you so much.


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Professor Bruce Greenwald:

All right, well go ahead and take questions. Can

we turn the lights up a little so we can see theaudience? I mean, I would be happy to takequestions from the audience if there are ones outthere, since Ah. Yes.

Speaker #1:

Thank you very much. Thank you for your kindremarks. Two questions really. You mentionedthat you are finally finding a fair amount of qualitycompanies with enduring franchises in Asia.Right? Quality enduring franchises. Two-part

question. When we look at the non-SOEs inChina, the non-SOEs, how many do you think willbe allowed flourish over a number of years? Imean, I see they are confiscating BYDs land;there was an article in Bloomberg last week abouta private auto company being forced to mergewith an SOE for political reasons that is part 1.Maybe an easier question is, since about 90% ofthe SOEs CEOs are appointed by the communistparty, what is their principal objective? Is it reallyto maximize shareholder value or to promote thecommunist partys agenda regarding China?

Mr. Cheah Cheng Hye:

Actually this is a fundamentally credible question,because the economic and political system of thePeoples Republic of China is not capitalism in theAmerican sense. It is a form of authoritarian statecapitalism. So, your question reflects the reality ofwhat this actually means. The SOEs are there tocarry out the concept that the party remains incontrol, although at the working level we have asystem of material incentives and backup forces topromote an efficient economy. Now, having said

that, I am not allowed to show you for compliancereasons my performance, but I can tell youverbally without giving you numbers because ofthe restrictions, that we have flourished essentiallyby focusing on private chips.

Private chips is the jargon used by the industryto describe non-state enterprises. From the 1990sonwards, I figured that these big gigantic state-owned enterprises were not my cup of tea. So, Iwent on my way to cultivate a small number of

private entrepreneurs who were allowed toflourish, and we took big stakes in them. Some ofthem let me down; they are some of my worst

losses, but those that you make money. You make10 beggars, you make 20 beggars, and they arestill your friends till this day.

So, the whole Value Partners fund was in facta kind of antimagnetic fund in the sense that themain game about China is the state-ownedenterprises, but we went the other way. Wefocused on the small number non-state enterprises,and the answer to your question, by the way, isthat forced mergers between private enterprisesand state-owned enterprises, as far as I know, arenot a major issue in China. It gets reported by themedia like Bloomberg, partly because the Western

media, of which I used to be a representativemyself, is very ideological. They tend to pick onthose stories and highlight it, but this is not themain landscape. This is only part of the landscapethat interests a Western audience.

Rest assured that most private enterprises inChina are left to their own devices for better or forworse, but the real body is not a level playingfield. If you are the private enterprise you dontget access to bank lending, bank loans; you dontget access to privileged locations, and you have towait a lot longer for licenses and other things. So,the playing field is very unfair if you are not a

state-owned enterprise. And the way to get aroundthat is to be corrupt yes!

So, there is a saying that may be less true, Imtrying to figure out what are the right words touse Im not good at discounting, is that youhave got to be friends with the governmentofficials. But every now and then, the governmentofficials turn against you and then they pick upyour file and say, you did XYZ corrupting back in1985. Sorry boys, you know, youre in jail.

See, its a very messy system. Yeah, a lot ofheartbreaks.


Okay, yes, go ahead.

Speaker #2:

(Inaudible)


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Okay, for people who didnt hear that question,

the question was: as the fund has gotten bigger andhas had almost of necessity to move into largercap stocks, how has that changed the investmentprocess?


The investment process actually has not changedfor us in response to size constraints or sizeconsiderations, I should say. It has changed inresponse to my intellectual frustration, with the

notion that both in the Western world and theEastern world, that successful, glamorous hedgefunds depend on star managers or mysteriousblack boxes. I think I tried to describe how I triedto change it into a process of very ordinarymanufacturing process, but the answer to yourquestion is on several levels.

First of all, I think at some point, firms ofValue Partners will come out against theconstraints of capacity. Yeah, I think thats theright word, capacity, yeah. We, in fact, brieflyclosed our funds several times in the past becausewe ran out of ideas. The way I have tried to do the

job is that I know that at some point I wont beable to take on any more money.

My self-interest is performance rather thansize, because I earn performance fees, which aremore important to me than the small annual fee Iget for size, and I have responded.

If you look at my website from last year withmy strategic partner, the Ping An InsuranceCompany of China, I launched an ETF division:Exchange-Traded Fund division. Three or fouryears ago, almost by accident I read the CFAjournal, a professor from New York, but it is kindof unfair, I forgot his name. He was writing about

the concept of fundamental indexing. He took theS&P 500, he picked the 25 cheapest stocks interms of fundamental value, at least the lowest PE,if I am not mistaken, and it worked, heoutperformed. I had simply copied his idea.

Okay, having succeeded with that, it was anastonishing example. I think Ill blow my trumpeta little bit here, of a local Hong Kong Chinese firmbeing able to penetrate into a space dominated by

2 western multinationals; BlackRock and I thinkStateStreet.

We are not supposed to get in there. We got in

there only because we came out of a differentiatedproduct.Now that we are successful, we are

conceptually, and I will choose my words, becausefor regulatory reasons I cannot kind of say toomuch, but we are coming out with similarfundamental indexing products for other assetclasses and markets across the Asian continent.

This will be my avenue for growth in futurebecause of the limitations of the actively managedstar.


In the back.

Speaker #3:

How does your research effort cover small andmedium-sized companies in Asia, which are notcovered by the institutional research community?To give you an example, IDS, which Li & Fungacquired a couple of weeks ago; it didnt have any

institutional research coverage on it at all, yeah.And if you just looked at it, you know that Victorand William Fung would support the company,and as part of that, when you have got somebodyreputable like the Fung Brothers behind thecompany, do you give it a higher valuation, if youwill, in terms of an asset allocation?


Oh, oh, there are two questions. The first is, howdo you go about doing research on companies if

there is no published research on those companies,except I assume the financials are available, sothats the first question. The second question is,how important is the reputation for integrity andthe quality of the people back in the companies,and how far does that affect your decision on theamount of money youll allocate to funds?


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Thank you for these questions. We are you are

talking with the right guy at this time because weare the pioneers of small-cap research and alsoChina B-share research. The lack of publishedresearch is a huge advantage. You dont reallywant someone else competing with you andresearching the company. You want to be the firstambulance on the scene, you know, so I estimatethat in my universe there are approximately 1000to 1300 companies with market capitalizationbelow US$1 billion.

I classify them as small cap stocks, and wehave an army of people there researching themand confidently buying them, usually through

structured deals; and these people are, franklyspeaking, desperate. They dont have a brand; theydont have a major institutional investor as theirshareholder, so we squeeze them. We usually ask,in one particular case I can still recall last year, weasked for the maximum discount of 19.9% to thequoted price in the stock market And the guysaid yes. Actually, I was astonished, but anyway Itook it, you know.

So anyway, so no research is a good ideabecause it means you are really, really in thepromised land, what I call Category #1.Remember I told you about Category 1, 2, 3?

Yeah. Now, the real trouble with some of theseguys are actually value traps. You could be inCategory 1 forever. You never make any moneyout of it, you know? It refuses to move down theconveyor belt to category 2.5, when you aresupposed to sell it, right? So, after you get in, it isfairly useful to try to encourage the management

to do more IR and talk to the media and come outwith this and that.

But, for your information, contrary to what

some people in our audience may think today, ingeneral, the accounting standards for Hong Konglisted companies is very high; it is world class. Itis typically done by a Big-4 auditor.We actually have the head of E&Y here, he usedto work in Hong Kong for many years.

Anyhow, and the regulators are incrediblystrict; they have a habit of jailing anyone whoviolates the securities regulations, so publishedaccounts are not an issue, it is not some MickeyMouse play at all.

Your second question is about integrity issues.This one is a tough one for me, too. I have been in

the market I am now 56 years old. I was anewspaperman from the age of 17 to 36, and fromthen on I was in the financial industry as a head ofresearch, and then a money manager, and to thisday I get fooled. I was fooled as recently as just ayear ago by this guy who ran a company calledPeace Mark who, however, was anything butpeaceful.

He ran a chain of watch shops selling fancyEuropean watches, and he disappeared after I hadput in about Hong Kong $40 million into hiscompany. We are still chasing him, and this guy islike the, I cant remember the term now. I think it

is something like the great grand wizard of theFreemasonschapter of Hong Kong, a pillar of thecommunity, the son of one of the most establishedcolonial families, etcetera. So what do you do?That is why I told you, right? You have to bediversified, do a lot of background checks, andpray for the best.

Value Partners Limited

Email: [email protected]: (852) 2880 9263Facsimile: (852) 2564 8487Address: 9th Floor

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Value Partners - Making It Work in China and Asia 20101021

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Transcript of Value Partners - Making It Work in China and Asia 20101021