Table of Contents
1. Large-Scale Mindset
2. Context is King
3. Personal Ethics
4. Unreliable Predictions
5. Reliable Markets
1. Large-Scale Mindset
Thanks for bearing with me, everyone. I cannot tell you how much I appreciate it. I have long Covid and cannot type for long on a computer screen without getting brain fog – but the good news is that as long as I do not look at a screen, my brain works fine! It’s frustrating, and the amount of time I get to work varies every day from zero to never-quite-enough, but I’m learning how to manage it (dictation! editing help! not letting the perfect be the enemy of the good!) and I’m slowly getting better. You will receive all the issues you are due as I catch up, and then we’ll be back to the regular biweekly schedule, and soon our AMA call.
The next issue will come on Saturday about Buffett’s latest letter. Then, we’ll get into his past Berkshire Hathaway letters, which I’m so excited to read together with you. Ever since I read the Berkshire letters when I first started this crazy idea of investing practice, I’ve wanted to go back and start reading them from the beginning over again. I was on my own the first time. It’s so exciting to do it now, and I hope you’ll join me as a little mini project in your own investing practice. More on the Berkshire plan in the next issue.
So that’s what’s coming up.
Now, here’s what I wrote a number of weeks ago about some reading I loved. My investing practice time still brings me such gorgeous, quick, moments of joy. So many of us only have a few minutes for investing practice, and I’m grateful to have that time at all. Meaningful investing practice can be done incredibly quickly. It doesn’t take me much time to read one page of a speech, and the amount I learned from reading one page of the speech value investor Li Lu gave at Peking University in 2015 was well worth the dip into it. Reading whole thing is even better.
Sometimes I feel a little niggling worry in the back of my mind when I take time to read the work of great investors that it’s time that could be spent studying the companies of today, instead of the thoughts of the past. However, then, when I read their work, it feels like a re-set of my priorities.
It expands my view from “how do I make money/not lose money?” to “what is my larger practice?” Keeping my mindset bigger, I firmly believe, protects me from the ups and downs of the market. So, onward – Li Lu, and soon Buffett’s letters.
2. Context is King
Context. Context is king.
Li Lu gave his speech, which he entitled “The Prospect of Value Investing in China,” in Beijing. In China. At one of China’s most prominent universities. Li Lu was born in China in 1966, and, according to the internet, is now an American citizen. China doesn’t allow dual citizenship, which means he’s no longer a Chinese citizen. He’s a US citizen, in China, giving a talk about ethics to Chinese students at a prestigious university – and while it’s unlikely China would take a prominent American for questioning, it’s not out of the question. Furthermore, he was a protest leader when he did live in China, and Chinese leaders tend to have long memories.
The risk to him was not zero.
China isn’t afraid to take powerful people. Jack Ma was not heard from or seen publicly for several months, Nov 2020-Feb 2021. It seems likely the Chinese government has put him somewhere after he got a little too big for his britches. Jack Ma, the billionaire founder of Alibaba, an online store in China much like Amazon. Alibaba had a payments arm called Alipay, which they spun off and named Ant, and filed for an IPO. On the eve of the IPO, Jack Ma made some comments publicly about the revolutionary power of Ant’s financial information and network. Soon after, he disappeared and the IPO was canceled by the regulators. It’s an interesting dive into how China’s upper echelon works, and I recommend reading a few sources. It’s quite engrossing. NPR, Asia Nikkei, BBC. He has not spoken about his disappearance, and showed up in February playing golf.
If someone as wealthy and connected as Jack Ma can be temporarily disappeared and completely silenced, then the Chinese government is making their point: they can take anyone. They also took the most famous Chinese actress for a few months and said it was for tax evasion. She’s back, but she’s not talking about it. Vanity Fair wrote an in-depth piece about her disappearance and the tentacles of Chinese government in the Chinese film industry that is especially informative when read through the lens of Jack Ma’s current disappearance and the Chinese government’s apparent fear of losing control of the financial system.
As an American, Li Lu has more protection than these Chinese citizens. Taking him would be an international incident. However, I don’t think that means it wouldn’t happen. The way he danced around Chinese misdeeds in his 2015 speech shows, in my view, that he was aware of the danger. My read is that he was careful, in this speech, not to offend China.
After all, Li Lu is the key man of a highly profitable business with investors who want him to be making the decisions. Himalaya is not some huge hundred-person shop. Himalaya Capital IS Li Lu. If he started insulting China and ran into issues that could stop him from being able to make investing decisions, his investor base could start to leave him.
2. Personal Ethics
With that context, I found it really interesting he started with ethics. Not unusual for a value investor to talk about ethics, and the ethical points he made are applicable to any financial professional: (1) seek truth and wisdom, and (2) be an unassailable fiduciary of your clients.
“What is fiduciary duty? Every penny entrusted to you by your client should be treated as though it were the money your parents had worked hard to earn and saved thriftily over their lifetime. Even if it is a small amount, it is the fruit of a family’s lifetime of hard work and frugality. When you can treat every penny of your client’s money as the life savings of your parents, you will begin to understand the meaning of fiduciary duty.” (p.5)
All of us here in the Invested Practice community invest our own money (and maybe that of our parents) so this concept is real for us. Our fiduciary duty is baked in. It comes without a second thought.
It’s important to remember, though, that for others, it feels different. Their incentives are different. Explains why they make different decision than we do at times.
Chinese companies are maligned for cooking their books, stealing intellectual property, bribing corrupt government officials, being overly close with crony government officials, willingly going along with excessive government surveillance – to name a few accusations. I would expect that some financial professionals know about this stuff and either go along with it or profit from it.
Indeed, value investing’s fundamental tenet of stock ownership, rather than stock trading, which Li Lu went into later in his speech, means that as a fiduciary-owner you must recognize the risk the company incurs by engaging in questionable and possibly illegal behavior that could damage the company in the future. He said nothing about that subject, though.
3. Unreliable Predictions
One of my favorite parts was when he acknowledged – FINALLY! – that it’s almost impossible to be truly confident of a prediction about a company.
“Understanding a company or an industry means you can predict what state the company/industry will be in 5 or 10 years, by no means an easy task. However, before we make an investment decision, we need to know what situation the company will be in. What will happen if there is an economic downturn? Otherwise, how can we know if the value of the company is higher or lower than the price? We need to have an estimate of the company’s future annual cash flow for the next 10 or 20 years to discount them to today’s value (present value of future cash flow). It is difficult to know what shape your company will be in, even as the founder. You may say, ‘of course I know,’ and undoubtedly say this to your customers and investors. You may even tell your employees that the company aspires to the Fortune 500. In reality, you probably cannot predict the company’s growth more than 10 years into the future, as few can due to innumerable uncertainties. This does not mean it is a completely lost cause. You can probably predict with high degree of confidence the worst case scenario for selected companies and industries over the next ten years. They may perform better than expected. However, this skill requires relentless effort and studies, along with many years of hard work….most people are not willing to make the effort. You can spend a lot of time, yet still understand very little.” (p.16)
I say FINALLY because I notice regularly how many value investors announce how confident they are in the near-certainty of their investment choices, and it drives me crazy. I understand that we’ve got to be confident to put real money behind an opinion. But lots of crazy things can happy. Li Lu says there are “innumerable uncertainties.” He is correct. “You can spend a lot of time, yet still understand very little.” YES.
Investing practice is about not spending a lot of time, and understanding a lot. It’s about choosing a great leader who will hopefully make smart decisions as those innumerable uncertainties show up. Like a pandemic.
Then, he went into our own personal investing practices, inside our own heads. Overconfidence.
“If you are a true value investor, you won’t go on a TV money show to critique the stock prices of all companies, or tell others what the stock prices should be. You won’t casually state 5000 point is too low, that a bull market is imminent, or that 4000 point is a bottoming out. You will know that such pronouncements are outside of your circle of competence. No matter how big the circle you draw, those statements won’t fit into it, and those who set the boundaries of the circle beyond their competence are destined to be destroyed by the market at some point or somehow. As I stated previously, the market is a mechanism that discovers your weaknesses. Any fault/defect you have will be magnified infinitely, to the point of complete destruction.” (p.16-17)
Oof. Complete destruction. I agree, though. We feel our mistakes much more strongly than our wins. Personally, I think when it comes to investing decisions, we feel the wins like “eh” because we EXPECT our decisions to be correct. So when it turns out they are – cool, move on.
However, when it turns out they’re not correct, then that’s a shock, it causes a bunch of questions internally about what led to that incorrect decision, and everything gets reviewed. Feeling the losses much more intensely is not totally rectifiable, by our very nature as humans, but the approach I take in my practice is to review all losses AND wins in the same way. It takes some of the emphasis off the negative side of things and creates more balance. Not perfect, but you know – we’re human.
Li Lu combats faults/defects by being ruthless with himself in his search for truth.
“Therefore, one basic requirement for professionals in this industry is to be completely and one hundred percent intellectually honest. It is easy to deceive oneself, particularly in this industry, but one should never do it. From where you sit, you can tell people all kinds of lies. When you tell them over and over again, you begin to believe them yourself. However, these kinds of people will never become outstanding investors. Rather, they will be destroyed sooner or later by the market. That’s why the industry has not produced many long-term superstar investors. Some of those we talk about as superstar investors might have 20% returns for 10 plus years in a row. But when they close their funds we find they have suffered losses of more than 50%.” (p.17)
He later said:
“Even if you give me a track record for the past 5 or 10 years, I still cannot make a determination. I must know what’s in his portfolio, and I can only make my judgment after observing him over a very long period of time.” (p.2)
I’ve often figured ten years should be a good time frame to determine whether an investor is good or lucky. Li Lu disagrees, and he actually convinced me. The market can be favorable for a very long time, after all.
“During a continuous run of 15 years in which the market provides an average compound return of 14% you don’t have to be a genius at all. All you need to do is to get in the game and ride the market to see excellent returns. The table can also be turned to where the market shows negative returns for 10 plus consecutive years. If you can succeed under these market conditions, you are a true genius. This is what I meant when I said that without looking at the specific content of your investments it is generally difficult to judge your competence. However, if my investment manager can maintain excellent performance for more than 15 years, and he does his research in the right way, then he will generally become a competent professional.”
Or, to think of it separately from a certain time period: if someone can succeed under adverse market conditions, when the market is sideways or negative for a long time, then that person is probably pretty good.
Be honest internally. Be honest externally. Do both for a long time.
4. Reliable Markets
When he got into human civilization and modern China, what stuck out to me glaringly were that he attributed the steep rise of GDP to (1) modern science and technology, and (2) the free market economy.
Absolutely agree.
However, I’d add, importantly, a stable government, reliable information, and reliable investment exchange. Without a reliable legal structure and a reliable exchange of money and ownership, the free market economy would not be able to raise investment funds anywhere near as easily because the risk would be much higher. It would be private entities only, making private transactions, using private contractual terms and conditions. The charts of GDP growth he includes start the exponential growth around 1800, and that’s about when the Western exchanges got going. Furthermore, the rise in the last twenty years of reliable investment information has reduced the information asymmetry between investors and companies, which also has reduced the risk dramatically.
I think he didn’t comment on reliable governments or trustworthy information out loud because saying so in China would probably be considered criticizing the government, and we’ve seen the dire consequences of doing so. So, he danced around it, and very effectively.
I think he gave a very good speech that, without criticizing China even once, encourage these future financial professionals to behave better and hold high standards for their own work. He also, without quite saying it, said to China’s government that if they want to continue their economic growth (and therefore their economic power), they must push towards ethical standards of governance.
I can do the same – push myself to invest in companies with ethical standards of governance. Be honest internally. Be honest externally.