Recently, our managed products have experienced some setbacks. Therefore, I think it is necessary to communicate with investors before the monthly report (or mid-year report) to reiterate our investment philosophy, review the recent operation of the products, and provide outlook for future operations.Our investment philosophy:
Firstly, although many of our investors have been with us for a long time, it is still necessary for us to briefly explain our investment framework. In short, our methodology can be summarized as investing in growth opportunities using a value investment approach, with a focus on the technology and consumer industries in global markets.
While the phrase "investing in growth opportunities using a value investment approach" may sound simple, the degree to which it is implemented can vary greatly, including our own continuous learning and experience in practice. The philosophical foundation behind this idea is actually a kind of "rational optimism", which means that we always look optimistically at future opportunities, while at the same time, we are filled with a realistic, conservative, and cautious attitude. It may sound a bit mediocre, but it also means that our values and risk orientation are basically in the middle, and we believe that although there will be outliers (such as particularly talented individuals), in most cases, the world operates more in line with this moderate attitude. The practical orientation of this attitude can be considered a kind of proactive and enterprising attitude, while maintaining a sense of vigilance and caution at all times.
In other words, our investment philosophy is always based on a longer-term world or human society that may be more likely to remain in a relatively cautious and optimistic state (mathematically speaking, we believe in consistency rather than jumps), rather than on our constant speculation about the position that the world may be in currently or in the short term. We have a relatively sufficient understanding and confidence in the status of the world or human society in a relatively long time dimension (because this is determined by more underlying sociology, biology, and even more underlying mathematical physics), but we cannot predict the state that the world will present in a relatively shorter time dimension: it could present a very cautious and conservative step-by-step approach or even regression, or it could be wildly optimistic and radical, or it could simultaneously demonstrate both states. There are quite a few investors whose investment philosophy is actually a kind of ignorance, or the state of not making long-term judgments. They are just constantly guessing the market's preferences and temperaments in the short term. Of course, we know that there are some investors who are tirelessly good at this, but unfortunately, this may not be us.
In summary, our investment philosophy means that our investment methodology has a certain degree of rigidity (a state selection that is more sustainable in our longer-term dimension) but lacks flexibility and adaptability to the market. Of course, this only refers to the flexibility and adaptability to the market. We always closely track and adjust our expectations appropriately in response to changes in the real underlying status (because we know that even with the most careful and cautious human judgment, it is possible to make mistakes).
Our investment process is a very rigid process, which has little to do with the recent performance and preferences of the market. The main process is divided into three steps:
Conducting competitive analysis and selecting companies that we believe can maintain a competitive advantage in the long term.
Conducting Runway growth prospects analysis and selecting companies that we believe have greater future growth opportunities.
Conducting pricing analysis and making compound return judgments based on our considerations of growth opportunities, speed, feasibility, and valuation, among many other factors. Our bottom line for investment opportunities is a >15% compound return opportunity.
Overall, our investment philosophy is a stock selection strategy based on methodology, rather than a top-down, sector rotation, and market preference selection approach.
In recent review:
Our product has experienced some pullback recently. Some of it we believe is due to market factors and other reasons, and some of it is due to our previous judgments being inaccurate. Due to our concentrated holdings and relatively low flexibility, short-term fluctuations are more severe. The specific reasons for this include:
The education sector has experienced a significant decline, including both fundamental and emotional impacts. Specifically, the most severely affected by policy are K12 education and training: the new Civil Education Law directly halted related transactions, challenging the profit model of K12 education, and the training business has recently been subject to intensive rectification, with restrictions on duration and enrollment, which will have a very serious impact on the utilization rate, new establishments, enrollment, and profit margins of their network. These impacts will have a very serious effect on long-term revenue growth expectations and potential profit calculations, making pricing models impossible to evaluate reasonably (because it could even be zero under the most pessimistic scenario). Before the implementation of the regulations, we had a small K12 education holding, and in the face of a 20% decline after the regulations were implemented, we still chose to liquidate all positions at the first opportunity based on the situation of the reasonable pricing model being impossible to evaluate, and we are unlikely to buy back in the visible future before any major policy shift occurs. Currently, all of our education holdings are in higher education, and we believe that the recent decline is more of an emotional impact, as the overall policy guidance encourages higher and vocational education. We understand the logic of some investors' panic, because overnight, they realized that as a people's livelihood industry, policy risks in socialist countries could be sufficient to cause a high barrier, strong stickiness, and high brand power leading company such as TAL Education and New Oriental to almost collapse overnight. In this context, it is understandable that investors' confidence in higher education companies has been shaken, as no one can guarantee that the policies that are supported today will not completely turn around overnight in the future. This cannot be said to be a display of irrational fear. However, we still tend to adhere to the higher education field for the following reasons: 1. Under the current panic situation, these companies can provide extremely high long-term investment cost-effectiveness, with a large number of companies having a clear 3-5 year development path and the potential for profits to grow 2-3 times, while the current static valuation is only 10-20 times, both relatively and absolutely undervalued; 2. With the Civil Education Law already in place and the top-level positioning of higher and vocational education already established, we believe that the policy is likely to continue to be supportive for at least the next five years, and significant policy adjustments are not easy to make; 3. From a long-term social perspective, higher and vocational education is more of a skill-increasing type, rather than just providing internal competition (as criticized in K12 education), and is also more market-oriented and oriented towards more diversified social needs, which also means that private education can provide services that public mechanisms cannot achieve.
We also made some misjudgments on the fundamentals of some individual stocks, the most notable of which was the overestimation of the competition barriers of an e-commerce company (which was not really overvalued at the time). However, the status of the industry slowdown and increased competition this year was somewhat underestimated, and even more underestimated was the market's violent reaction to this, which allowed us to see the drastic fluctuations in market pricing of second-tier companies defined in the market with no obvious fundamental miss. But for another company, our focus was more on its growth logic, but we didn't pay enough attention to its corporate governance issues, which also caused short-term market volatility.
Another important reason for our underperformance this year is that we have not been able to obtain sufficient returns from other more attractive sectors and stocks. This is largely due to our relatively rigid selection criteria: stricter requirements for competitive advantages and the demand for potential investment returns (above 15% annually), which make it difficult for us to find suitable targets in the most active technology and consumer sectors. In addition, our other holdings have not provided us with sufficient compensation for the losses caused by the sharp fluctuations in other sectors.
Future Outlook:
These fluctuations can be very painful, especially when there are some structural losses that may take a long time to recover. Therefore, even if we suffer losses, we may have to cut our losses and give up some positions, as we mentioned earlier with some positions in the compulsory education stage. Even if they are excellent companies with strong competitiveness and very undervalued, once policies significantly affect their profit models, we may have to admit our mistakes.
However, some fluctuations are purely emotional, even if they are reasonable concerns. At the same time, we need to be aware that no company is perfect, especially not perfect and sustainable. Therefore, we still need to consider the risk and return on investment after fully considering these concerns. In any case, investment is a challenge that requires taking risks to obtain returns. What we need to do as investors is to try to obtain as much return as possible with as little risk as possible (here, risk refers to fundamental risks, not just fluctuations in stock prices).
Although our methodology is not based on frequent trading to speculate on market aesthetics, it does not mean that we should stick to wrong choices. Our principle of adjusting positions is based on two factors:
The fundamentals of the target company no longer meet our stock selection criteria.
There are better targets that can provide better risk-return combinations and diversification to improve the overall portfolio's risk and return.
In addition to this, we are unlikely to change our judgment based on market sentiment fluctuations. In front of solid fundamentals, our strategy is more likely to be a contrarian investment approach because a drop in stock prices often brings about an increase in these companies' future expected rates of return instead of a decrease.
Concentrated and high position vs. diversified portfolio:
We still have a general question of why we chose a concentrated and high position approach instead of reducing positions when it is difficult to find enough targets in the technology and consumption sectors with better risk-return ratios based on our standards. We understand that a concentrated and high position approach will increase the portfolio's volatility, but we believe that cash positions do not create returns in the long run. In other words, although cash can reduce volatility, it still has a high cost and price in terms of losing long-term compounding opportunities. When choosing between higher compounding returns and volatility, we still prefer higher compounding returns.
Based on the above points, our future outlook and holdings are as follows:
We believe that the valuation of leading large-scale technology companies in the US market is relatively reasonable and not significantly overvalued. Therefore, we still hold some large-scale growth companies.
Small and medium-sized service companies with low valuations in the Hong Kong market are still seen as growth companies with a lot of undervalued potential.
After significant valuation adjustments recently, we hold and may increase positions in some high-quality Chinese overseas technology companies.
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