The Prospects for Value Investing - · PDF fileTranslated by Graham F. Rhodes, CFA Page 1 of...
Transcript of The Prospects for Value Investing - · PDF fileTranslated by Graham F. Rhodes, CFA Page 1 of...
TranslatedbyGrahamF.Rhodes,CFA Page1of37
LiLu:TheProspectsforValueInvestinginChina
October28th,2015
Originalsource:http://36kr.com/p/5040874.html
First,thankyoutotheGuanghuaSchoolofManagementandthankyoutoProfessorJiang
Guohuaforestablishingacourselikethistofocusontheprinciplesofvalueinvesting.
Launchingavalueinvestingclassatthistime,inmyopinion,isofgreatsignificance.AsI
understand,thisisthefirstandonlyclassofitskindinChina.Therearen’tmanysimilar
classesaroundtheworldeither.AsfarasIknow,theclassatColumbiaUniversitymaybe
theonlyother–thatis,theclassfirstofferedsome80or90yearsagobyBuffett’steacher,
BenjaminGraham.HimalayaCapitalisproudtosupportthisclass.
Iwouldliketodiscussfourtopicswithyoutoday:
First,sincemanyofthestudentsenrolledinthisclassarelikelytojointhefinancialservices
orassetmanagementindustries,Iwouldliketobeginbytouchingontheuniquefeaturesof
theseindustries,andthemoralbottomlinerequiredofpractitioners.
Second,asassetmanagementprofessionals,wemustknow,fromalong-termperspective,
whichfinancialassetscangrowinasustainable,effective,safeanddependablemanner?
Third,arethereanyeffectivemeansbywhichthroughhardworkyoucanbecomean
outstandinginvestorcapableofprovidingyourclientswithanhonestanddependable
servicetoprotectandgrowtheirwealth?Whatisthe‘truepath’intheworldofinvesting?
Fourth,aretheinvestmenttechniquesproveninmature,developedcountriessuitedto
China?OrisChinaanexception?CanvalueinvestingbepracticedinChina?
Ihaveconsideredthesequestionsforseveraldecadesnowandwilldiscussthemwithyou
today.
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1. Uniqueaspectsoftheassetmanagementindustryandthemoralbottomline
requiredofpractitioners
Assetmanagementisaserviceindustry.Comparedwithotherserviceindustries,whatare
itsdistinguishingfeatures?Inwhichaspectsdoesitdiffer?Ibelievetherearetwo
differences.
Thefirstisthatintheoverwhelmingmajorityofcases,theconsumersofthisindustryhave
nomeansorideaofhowtojudgeitsproducts.Thisisdifferentfromalmosteveryother
industry.Forexample,someonecaneasilytellyouifacarisgoodornot;oriftheyouteat
out,theycantellyouimmediatelywhatthefoodwaslikeandiftheservicewasgood.Ifyou
stayinahotelorbuysomeclothes…inalmosteverycase,youcanevaluateaproductjust
byusingit.However,consumersofassetmanagementproductsinmostinstanceshaveno
wayofknowingifaproductisgoodorbad,oriftheservicetheyarereceivingispooror
outstanding.
Notonlyconsumersandinvestorsbutevenpractitioners–includingsomeoftheindustry’s
topstarswhohavejoinedustoday–willhaveahardtimeevaluatinganinvestmentproduct
orservice.Thisisthekeydifferencebetweenfinance–andespeciallyassetmanagement–
andpracticallyeveryotherindustry.Ifyougivemeayearortwoofresults,Iwillhave
absolutelynowayofevaluatingwhethertheyareoutstanding.Itwouldbesimilareven
withfiveortenyearsofresults.Youmustlookatwhatinvestmentsweremade,andstill
youcanprobablyonlymakeausefuljudgementafteranequallylongperiodoftimehas
passed.Preciselybecausethereisnowaytoproperlyevaluateproductsandservices,the
overwhelmingmajorityoftheoriesgetthingsass-backwards.
Anotherkeydifferenceisthatoverallcompensationinthisindustryishigherthanothers,
andoftendetachedfromresults.Infact,theactualserviceprovidedtoclientsinmostcases
isverylimited,andmanyproductsoftendeliverthebestreturntopractitioners.The
industry’spricingstructurefundamentallyreflectsthebenefitsofpractitioners,notclients.
Inmostindustries,onehopestoliftone’sstandardsinawaythatisobvioustoclientsand
whichwillallowforsomekindofpremiumpricing.Butinassetmanagement,irrespectiveof
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goodorbadperformance,everyoneusesamethodofcalculatingfeesbasedona
percentageofnetassets.Soregardlessofwhetheronemakesmoneyforone’sclientsor
not,onewillstillgetpaid.Theworstisprivateequitywherethepercentageofnetassets
chargedbordersontheoutrageous.Ifyourclientmakesmoney,yougetpaid;ifyourclient
losesmoney,youstillgetpaid.Eventhoughclientscanbuypassiveindexproducts,asa
fundmanager,youcanstillearnalotofmoneyevenifyouunderperformyourindexbya
widemargin.Thisisveryunreasonable.
Ithinkeveryonethinksaboutjoiningthisindustryisinpartfortheintellectualchallengeand
inpartforthecompensation.Whilethecompensationisundoubtedlyveryhigh,it’svery
hardtodeterminewhethermostmanagersareworthit.
Takentogether,thesetwouniquecharacteristicscreatesomeobviousdrawbacks.For
example,abilitiesaremixed,badproductsarepassedoffasgoodones,andmanymanagers
seemtobetherejusttomakeupthenumbers.Standardsintheindustryareconfusing.
Thereisafloodofspeciousstatementsandfallacieswhichconfuseconsumers.Evensome
managerscannotseethingsclearly.
Thesecharacteristicsposetwofundamentalmoralrequirementsonallmembersofthe
industry.
Iwouldliketodiscussthisissuefirsttodaybecausemanyofthestudentssittingheretoday
willbecomepractitionersinthefuture.Moreover,sinceoneoftheultimategoalsofthis
classistotrainthefutureleadersofChina’sassetmanagementindustry,Iwouldlikebefore
youentertheindustrytokeepinmindtwounbreakable,bottomlinemoralrequirements:
First,makethepursuitofknowledgeandwisdomyourmoralresponsibility.Youmust
consciouslyrejectanyass-backwardstheories.Onceyouentertheprofession,youwill
quicklyrealisethatalmostalltheoriesareofthiskind.Ifyoudon’tthinkaboutthisclosely,
youwillsoonconfuseyourinterestswiththeclient’s.Thisisjusthumannature;noonecan
avoidit.Becausethisprofessioniscomplicated,itisfullofspeciouspointsofview.Even
thoughtherearemanyjudgements,itisnotanexactscience.SoIreallyhopethatany
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youngpeoplewhoarewholeheartedlytryingtoentertheprofessioncanletthiskindof
moralbottomlinetakeroot;youmustmakethecontinuouspursuitofknowledge,truthand
wisdomyourmoralresponsibility.Asaninformedpractitioner,don’tknowinglytrotout
thosetheorieswhicharegoodforyoubutnotyourclient.Don’tletyourselfbeconfusedby
specioustheories.Thisisvery,veryimportant.
Thesecondistofirmlyestablishanawarenessoffiduciaryduty.Whatarefiduciaryduties?
Youmusttreateverydollarofclientmoneyasthoughitwerethefruitofyourownparents’
labour,saveduppiecebypieceoveralifetimeofdiligenceandthrift.Evenifit’snotmuch,
ittookyearsofstruggleandsacrificetoaccumulate.Ifyoucanunderstandthe
responsibilitythisentails,thenyoucanstarttounderstandthemeaningoffiduciaryduty.
Ithinktheconceptoffiduciarydutyisinnate:peopleeitherhaveitortheydon’t.Everyone
sittingheretoday,whetheryouentertheindustryinthefutureorentrustyourmoneyto
someoneintheindustry,youmustseeifyouhavethistraitorelsefindsomeonewhodoes.
Thosewithoutcannotbetaughtitbyanymeans.Anditreallywillbetragicifyougiveyour
moneytosomeonelikethat.Soifyouwanttoentertheindustry,youmustaskyourselfif
youhavethissenseofresponsibility.Ifyoudon’t,Iurgeyounottobecauseyouwillmost
certainlybecomethewreckerofcountlessfamilies.Thefinancialcrisisof2008-09wasin
largeparttheresultoftheso-called‘success’ofpeoplewhodidnotunderstandtheir
fiduciaryduty.Thiskindof‘success’isextremelyharmfultoallofsociety.
ThesearethetwomoralbottomlinesIwantedtosharetodaywitheveryonethinkingof
enteringtheassetmanagementindustry.
2.Astheassetmanagementindustry,wemustknow,fromalong-termperspective,
whichfinancialassetscangrowinasustainable,effective,safeanddependablemanner?
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Inwhatfollows,wewillanswerthesecondquestion:fromalongtermperspective,which
financialassetscanreallydeliverforclientsandinvestorsadependablereturn?We’vejust
experiencedastockmarketcrashandmanypeoplefeelthatcashorevengoldarethemost
dependableassets.Dowehavethemeanstoassessthepastperformanceoftheseassets?
Andhowlongis‘longterm’?Ithinkthelongerthebetter.Andthebeststatisticswillbethe
oldest,mostcontinuousstatistics.Becauseonlywiththiskindofdatawillwehaveany
persuasiveness.Inmodernsociety,thedevelopedwesterncountriesarethebirthplaceof
themoderneconomyandsawtheearliestdevelopmentofmodernmarkets.Becausethey
havethelargestvolumeofmarketdata,andthelargesteconomies,theycanshedthemost
lightonthisquestion.Andforthisreason,wewillfocusonAmericabecauseithasgood
datawhichgoesbackforalmosttwohundredyears.Soinwhatfollows,wewilllookat
America’sperformance.
ProfessorJeremySiegeloftheWhartonSchoolattheUniversityofPennsylvaniahasworked
hardoverthepastdecadetocompileasetofreliablestatisticsshowingtheperformanceof
variousfinancialassetsinAmericagoingallthewaybackto1802.Todaywewilllooktosee
whichfinancialassetperformedbestoverthistime.
Figure1:PerformanceofFinancialAssetsinAmericafrom1801totoday
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Thefirstmajorcategoryofassetiscash.Recentvolatilityinthestockmarkethasincreased
manyChinesepeople’sawarenessoftheimportanceofcash.Perhapsmanypeoplenow
thinkthatcashcanbestpreserveitsvalue.Solet’slookatcash’slongtermperformance.If
youhadadollarin1802,howmuchwoulditbeworthtoday?Whatcoulditbuy?Asyou
canseefromFigure1,theanswerisfivecents.Overtwohundredyears,cashhaslost95%
ofitsvalue,ofitspurchasingpower!Weshouldallbeabletoguessthereasonwhy:
inflation.Nowlet’slookattheotherassetclasses.
FormanytraditionalChinesepeople,gold,silverandheavymetalsareanexcellentmeansof
preservingwealth.Westerncountriesheldtothegoldstandardformanyyearsduring
whichtimegolddidholditsvalue.However,the20thcenturysawacontinuousdeclineinits
value.Usinggoldasthebestrepresentativeofpreciousmetals,howmuchwouldadollarof
goldtwohundredyearsagobeworthtoday?Whatwoulditspurchasingpowerbe?Wecan
againseefromFigure1thatitwouldbeworth3.12dollarstoday.Sogoldhaskeptitsvalue
andevenappreciated3-4timesovertwohundredyears,beatingexpectationsalthoughnot
reallyappreciatingthatmuch.
Let’slookattheperformanceofshort-termgovernmentbillsandlong-termbonds.The
yieldonshort-termgovernmentbillsisagoodproxyfortherisk-freerate,nevertoohigh
andjustabovetherateofinflation.Overthelasttwohundredyears,billshaveappreciated
by275timesandbondsby1600times,alittlebitmore.
Andontoequities,anotherofthemajorassetclasses.Manypeopleperhapsthinkthat
stocksaddriskandcannotholdtheirvalue,especiallyaftertheupsanddownsseeninthe
stockmarketoverthelastthreemonths.Havinggonethroughbothabullandbearcyclein
thelasteightmonths,manypeoplewillnowbemuchmoreawareoftheriskofequities.So
howhaveequitiesperformedoverthelasttwohundredyears?Ifwehadinvestedadollar
intheAmericanstockmarketin1802,howmuchwoulditbeworthtoday?
Theresultisthatadollarinvestedinthestockmarket,evenafterallowingforinflation,
wouldhaveappreciatedamilliontimestobeworth1.03milliondollarstoday.Eventhat
remainderisworthmorethanwhatotherassetclasseshavereturned.Andwhyhave
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equitiesbeenabletoproducethisperhapssurprisingresult?Theansweristhatevenafter
theeffectsofinflation,equitieshavereturnedacompoundaveragerateof6.7%.Thisisthe
powerofcompoundinterestandthereasonwhyEinsteincouldcallittheeighthWonderof
theWorld.
Theseresultsraiseanimportantquestion:whydoeseveryonethinkthatcash,anasset
whichovertwohundredyearshaslost95%ofitsvalue,issaferthanequities,anasset
whichhasappreciatedamilliontimesovertwohundredyears?Andthatmilliontimesis
evenafterallowingforinflation.Whyhavetheperformanceofcashandequitiesdiverged
tothisdegreeovertwohundredyears?Thisisaquestionallofusprofessionalinvestors
mustconsider.
Therearetwocausesofthisphenomenon.
Thefirstisinflation.AnnualinflationinAmericaoverthelasttwohundredyearshas
averagedaround1.4%.Thisisequivalenttosayingthatyourpurchasingpowerhasdeclined
byaround1.4%everyyear.Overtwohundredyears,this1.4%hasmadeadollarworthjust
fivecents,eroding95%ofitsvalue.Wecanunderstandthisveryeasilyfromapurely
statisticalpointofview.
Anotherreasonisgrowthintheeconomy,measuredbygrowthinGDP.America’sGDPhas
increasedbyabout33,000timesoverthelasttwohundredyears,equivalenttoanannual
growthrateofabitmorethan3%.Ifwecanunderstandeconomicgrowth,wecan
understandotherphenomena.Stocksareaproxyforlargecompaniesandtheirsales
growthisinturnafunctionofGDPgrowth.Allcompaniesincurexpenses,someofwhich
arefixedandbearnorelationtosalesvolumes.Inthisway,profitscangrowatafasterrate
thansales.Ifacompanycangrowsalesby3-4%,itsprofitsshouldincreasebyabout6-7%;
andsothevalueofthecashthecompanygeneratesshouldalsoincreaseatthesamerate.
Actualresultsseemtoconfirmthis.Thecorevalueofastockisthevaluetodayoffuture
profitgrowth.Overthelasttwohundredyears,stockshavebeenpricedatanaverageof
15xpricetoearnings,theinverseofwhichisabout6.7%,reflectingthegrowthrateofthe
market’searnings.Inthisway,equitypriceshavealsogrownat6-7%fortwohundredyears,
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resultinginanappreciationofamilliontimes.Sostatistically,wecanunderstandhow
equitiesinaggregatewillgrowatthisrate.
Thisistheinitialconclusionthen:inflationandGDPgrowthcanexplainthedifferencein
performancebetweencashandequities.
AnotherimportantquestionishowwastheAmericaneconomyabletoproducetwo
hundredyearsoflongterm,continuouscompoundgrowth?Allwhiletherehasbeena
persistentinflation?Howdidtheeconomygrowalmosteveryyear?Ofcourse,therewere
contractionsinsomeyears,andinotheryears,growthwasstronger.Butoverall,the
directionoftheeconomyoverthelasttwohundredyearshasbeenupwards.Ifwetakethe
yearastheunitofmeasure,thenGDPincreasedalmosteveryyearinawaythatwas
cumulativeandcompounding.Howshouldweexplainthisphenomenon?Werethe
conditionsuniquetoAmerica?Havetheyexistedthroughouthistory?Obviously,inChina’s
threeorfivethousandyearsofrecordedhistory,theyhaveneverappearedbefore.They
areindeedamodernphenomenonwithoutprecedentinChinauntilaboutthirtyyearsago.
SodowehaveawaytoestimatethepatternofGDPgrowththroughouthumanhistory?Is
thereaphenomenonofcontinuouseconomicgrowth?
WeneedtorefertoanotherFiguretoanswerthisquestion.Wemustmakeclearwhatkind
ofchangesoccurredinmankind’shistoryafterthedawnofcivilisationtooverallGDP,
overallconsumptionandthelevelofproduction.Ifweweretoincreasethetimespanofour
study,togobacktothedaysofthehuntergatherers,earlyfarmingandearlyagriculture,
howmuchwouldwefindmankind’sGDPgrowthtobe?Thisisaveryinterestingquestion.
Fortunately,Ihappentohavejustsuchafigure.ItwasproducedbyateamatStanford
UniversityledbyProfessorIanMorrisandusesmodernscientificmethodstoestimatethe
progressofmankindoverthelasttenthousandyears.Thisonlybecamepossiblethanksto
advancesmadeoverthelasttwentyorthirtyyears.Forthevastmajorityofmankind’s
history,economicactivityconsistedoffindingenergyandusingenergy.Correlation
betweenthisandtheGDPgrowthwearediscussingisextremelyhigh.Sointhelastsixteen
thousandyears,howhavetheconditionsbeenformankind’seconomicgrowth?
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Figure2:Theeconomicprogressofhumancivilisationoverthelasttenthousandyears
Source:IanMorris,SocialDevelopment,2010
Thefigureabove(Figure2)showstheresultsoftheStanfordteam’swork.Themost
importantcomparisonisbetweenEasternandWesterncivilisation.
FromFigure2,wecanseecivilisedsociety’seconomicperformanceforthelastten
thousandplusyears.ThebluelinerepresentsWesterncivilisation,fromtheearliesttimesin
theFertileCrescenttoancientGreeceandancientRome,andfinallytoWesternEuropeand
America.TheredlinerepresentsEasterncivilisation,fromitsearliesttimesintheIndo-
GangeticplainandChina’sYellowRiverbasin,laterenteringtheYangtzeRiverbasin,and
finallyemerginginKoreaandJapan.Thelefthandsideisfromsixteenthousandyearsago;
therighthandsideisfromtoday.Withoutusinganyspecialknowledgeofstatistics,youcan
saythatthesetwocivilisationshavebeenquiteequaloverhistory.Therehavebeenminute
differencesovertimeandyouwouldbeabletoseeevenmoreminutedifferencesifyou
reallydivedintothestatistics.Butoverall,growthhasbeenverysimilarthroughouthistory.
Yetoverasmuchassixteenthousandyearsofhistory,youwouldn’tsaytherewasno
economicprogressbutyouwouldhavetosayitwasminimal.Therehavebeenupsand
downs,butoverallithasbeenasthoughwewereunabletobreakthroughaglassceiling.
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Wecameclosethreeorfourtimesbutalwaysrevertedtofluctuatinginanarrowrange.
However,oncewearriveinthemodernera,wecanseethatinthelastthreehundredyears,
radicallydifferentconditionsemergedandhumanprogressshotup.Youcanseethislooks
almostlikea‘hockeystick’;itlookslikeonedollarbecomingamillion.
IfweenlargeFigure2andzoominonthesetwoorthreehundredyears,youcanseethat
thissegmentisverysimilartoFigure1.Theperformanceofequitiesoverthelasttwo
hundredyearsstronglyresemblesGDPgrowthoverthesameperiod.Andifyouzoomin
again,youcanseethatthelineisalmostvertical.Mathematicallyspeaking,thisisthe
powerofcompounding.Buttheconditionsallowingforcompoundgrowthhavenever
beforeexistedinhumanhistory;theyareapurelymodernphenomenon.
Figure3:Theeconomicprogressofhumancivilisationoverthelastfivehundredyears
Source:IanMorris,SocialDevelopment,2010
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Inthelonghistoryoftheworld,GDPhasbasicallybeenflat.ThisisespeciallysoinChina.
Takingtheexampleofthelastfivehundredyears,wecanseethesuddenascendanceofthe
WestandthattheEasttrailedbyaboutonehundredyears.TheriseoftheEastone
hundredyearsagoislargelythecontributionofJapan.
AnyonewhowantstounderstandtheperformanceofEquitiesoverthelasttwohundred
yearsandtheirperformanceoverthenexttwohundredyearsneedstounderstandthisline
–thecourseofhumancivilisation.Ifyoudon’tunderstandthis,itwillbeveryhardtostay
rationalduringastockmarketcrash.Eachtimewegetintoasituationlike2008or2009,it
willfeelliketheendoftheworld.Themostimportantthingininvestingispredictingthe
futurebutasthesayinggoes,“forecastingishard,especiallywhenit’saboutthefuture”.
Whyhasmankind’seconomicprogressbeenlikethisoverthelasttwohundredyears?It’s
veryhardtomakeanykindofforecastwithoutunderstandingthisquestion.Ihavethought
aboutthisquestionforalmostthirtyyearsandputmythoughtsintoamonographtitled
“SixteenLecturesonModernisation”.Anyoneinterestediswelcometohavealook.It’s
availableonthewebandProfessorJianghasalsobroughtalongafewcopiestoday.You
canfinditonmyblog,GoogleorBaidubysearchingfor“SixteenLectureson
Modernisation”.
I’vedividedhumancivilisationintothreestages.Thefirststageistheearliesteraofhunter
gatherers.IcallthisCivilisation1.0anditbeganabout150thousandyearsafterthe
appearanceofmankind.Foraverylongtime,humancivilisationwasnotmuchdifferent
fromotheranimals.Thebiggestchangesemergedinthe9thmillenniumBCwhen
agricultureandanimalhusbandryappearedintheFertileCrescent.Similarchanges
appearedinChina’sYellowRiverregionaroundthe5thor6thmillenniumBC,bringingabout
thesecondleapinhumancivilisation.Oureconomicstrengthatthattimewasalreadyquite
strongcomparedtothehuntergathererera.IcallthisCivilisation2.0anditwasbasedon
agricultureandanimalhusbandry.Thiscarriedonrelativelyconsistentlyforseveral
millenniauntilabout1750AD.SuddenlyfromhereGDPbeganincreasingeveryyearata
constantrate,tothepointwhereweconsideritamajoreventwhenGDPdoesnotgrow.It
isevenconsideredamajoreventwhenChina’sGDPgrowthslowsfrom10%peryearto7%.
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Thisisaverymodernphenomenonwhichhasalreadybecomeingrainedinourhearts.Its
causeismodernisation.ItentativelycallitCivilisation3.0.
ThiskindofdemarcationcanhelpusunderstandmoreclearlytheessenceofCivilisation3.0:
theentireeconomyexhibitscontinuous,cumulativeandcompoundinggrowthand
development.Youcanonlydiscusscapitalallocation,stocksandcashwheninvestable
financialassetsappear.Thiskindofdiscussionhasnomeaningpriortothatpoint.Inthis
way,ifyouwanttounderstandinvestingandgrowingwealth,youmustunderstandthe
sourceofwealthcreation.Theprinciplesourceisthathumancivilisationhasenjoyedover
thelasttwohundredyearscontinuous,accumulativeandcompoundingGDPgrowth.So
whatistheessenceofCivilisation3.0?Inthistime,foravarietyofreasons,modernscience
andfreemarketsappearedandtheircombinationshapedwhatweseeofCivilisation3.0.
Inthe“SixteenLecturesonModernisation”,Iexplainindetailtheprocessofmankind’s
evolutionoverthelasttenthousandplusyears.Ialsousetwoformulastounderstandthe
freemarketeconomy:‘1+1>2’and‘1+1>4’.Themostfundamentalevolutioninthe
moderneraisfreeexchange.IntheanalysisofAdamSmithandDavidRicardo,free
exchangeishowweachieve‘1+1>2’.Whensocietyadoptsthedivisionoflabourand
allowsfreeexchange,theeconomicvaluecreatedbytwopeopleortwoeconomicsystems
canbegreaterthanthevalueofwhatcouldbeproducedinisolation.Andthemorepeople
participate,thegreatertheadditionalvaluecreated.Thiskindofexchangedidexistinthe
agriculturalerabuttheappearanceofmodernscienceintensifiedthebenefitswhicharose.
Thereasonwasthatexchangemovedbeyondproducts,commoditiesandservicestothe
exchangeofknowledge.Thevaluecreatedbytheexchangeofknowledgeismuchgreater.
Accordingtomylectures,thisis‘1+1>4’.Whentwopeopleexchangeknowledge,they
learnmorethanjustwhattheotheristhinking;theirmeetingwillalsocreatethesparksof
newideas.Thesharingofknowledgerequiresnoexchangeliketradingcornformilk.But
whenyoucombineknowledgeyoubegintoseegrowthhappeninlargeincrementsthanks
tothebenefitsofcompounding.Onlywheneachexchangecanproducesuchlarge
incrementalbenefitswillsocietybeabletospeedilycreatewealth.
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Thiskindofcontinuousinter-personalexchangemultipliedbillionsoftimescreatedthe
modernfreemarketeconomy.AndthisisCivilisation3.0.Continuous,sustainable
economicgrowthisonlypossiblewiththiskindofexchange.Thiskindofeconomicsystem
istheonlywaytofullyreleasemankind’senergyandtruemotivations.Thissystemis
probablythegreatestinnovationinthehistoryofmankind.Itwasonlyafterthe
appearanceofthissystemthatwesawtheotherphenomenawehavediscussed,specifically,
thecontinuousgrowthoftheeconomy.Thosestudentswhowishtolearnmorecanread
mymonograph;Iwon’tsayanythingmoreaboutthistoday.
(Clarification:continuousGDPgrowthisthemeanstomeasurecontinuouseconomic
growth)
Inflationisamonetaryphenomenon.Inflationwilloccurwhenthesupplyofmoneyinthe
economyoutstripsthesupplyofgoodsandservices.Whydoesthesupplyofmoney
increase?Thecontinuousexpansionoftheeconomyrequirescontinuousinvestment.Ina
moderneconomy,thisinvestmentmustgothroughthebanks.Banksmustpayinterestto
attractsociety’sidlecapital.Sincethisinterestratemustbepositive,banksmustalso
chargeapositivelendingrate.Andsoifyouwanttogrowthecapitalinthesystem,you
mustincreaseitsquantity.Andifyouwanttoachievegrowthintherealeconomy,there
mustbeinvestment.Thetimingdifferencebetweenthesetwoactionscreatesinflation
almostasanassociatedphenomenonofeconomicgrowth.Ifyouwanttoinvest,this
investmentwillfirstbecomeadeposit,thensemi-finishedgoodsandfinallythefinished
goodsthemselves.Andonceyoudepositthatinvestment,thesupplyofmoneywill
automaticallyexceedthesupplyofgoodsandservicesintheeconomy.It’sthistiming
differencethatcreatesinflation.Thesetwophenomena–continuouseconomicgrowthand
inflation–explainthelargedifferenceinperformancebetweenCashandEquities.
3. Whatisthe‘truepath’ofinvesting?Howdoyoubecomeanexceptionalinvestor?
Foranindividualinvestor,arelativelygoodmethodistoinvestinequitiesandstrenuously
avoidcash.Butequitymarketsarevolatileandalwaysfluctuateupanddown.Andinthe
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shorttermwhenweneedcapital,thosefluctuationscanbeverysizeable.Let’slookatthis
tablebelow:
Figure4: USEquityreturnsbyperiodfrom1802to2012
FromFigure4wecanseethattheaveragelongtermreturnfromAmericanequitieshas
been6.6%.Moreover,theaveragereturneverysixdecadesorsohasbeenroughlyequalto
thisnumberandfairlyconstant.Butwhenwelookcloseratshorterperiodsoftime,wesee
thatperformanceisverydifferent.Forexample,theaveragereturninthepost-warperiod
from1946to1965wasabout10%,alothigherthanthelong-termaverage.Butinthe
followingfifteenyearsfrom1966to1981,notonlywastherenoincrease;valuesfell
continuously.Theninthenextsixteenyearsfrom1982to1999,equitiesreturnedan
averageof13.6%ayear,anotherhighrate.Buttheninthefollowingthirteenyears,
equitiesenteredanotherperiodofcontinuousdeclines.Throughoutthistime,valueswere
falling.ThisiswhyKeynesfamouslysaidthat“inthelongrun,wearealldead.”Eachoneof
ushasafiniteinvestmenthorizon.Mostinvestorswithapublicrecordhaveonlytenor
twentyyearsofresults.Butifyoumissed1981andstartedin2001or2002instead,your
tenyearsofincomemightallbenegative.Soasinvestors,ifwelookatequitiesthisway,
thenanindexmightbeOK.Butanindividual’sreturnscanbespecifictoaspecifictime
period.Youmighthavetenyearsofcontinuousnegativereturns.Butinanotherperiod,
youmightfeellikeaRockstarandearn14%annualreturnswithoutliftingafinger.Ifyou
don’tknowhowthisreturnwasobtained,youwillhavenowaytodetermineifitwas
throughluckorskill.
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Ifweassumeaten-yearinvestmentperiod,youwouldfindithardtoguaranteea
considerablereturn.Thisisaproblem.Atthesametime,thestockmarket’svolatilityat
differenttimescanbeverystrong.Sothequestionwemustaddressis:isthereareliable
waytoinvestacrossdifferentperiodsoftimewhichcanproduceasuperiorreturntothe
indexwhilestillprotectingclientassets?Whichcanallowclientstoachievealongterm,
reliableandexceptionalreturnbyparticipatinginthatprocessofeconomiccompounding?
Isthereawaytoinvest–nothingheterodox–whichcanberepeatedandstudied,and
whichcanbringusthiskindofresultoverthelongterm?Thisisthequestionwewillseek
toaddress.
Inthelastfewdecades,asfarasIknow,therehasbeeneverykindofinvestmentstyle.And
asfarasIcanobserveandspeaktowithstatistics,therehasonlybeenonestylewhichhas
reliablyandsafelybroughtinvestorsexceptionallongtermreturns:valueinvesting.I
realisedthattherearescantfewlongtermtrackrecordstousetoillustratethis,andthatof
thoseIcouldfind,practicallyallwerevalueinvestors.
Thebiggesthedgefundsinthemarkettodayprimarilyinvestinbondsandhaveproduced
goodresultsovertenyearsormore.Butoverthattime,thereturnonrisk-free,long-term
bondshasgonefrom6-8%topracticallyzero.Ifyouhadusedtwotothreetimesleverage,
youwouldhaveearned10%.Ifyouhadusedfivetosixtimesleverage,youwouldhave
earnedabout13%.It’sveryhardthentotellifthesefunds’resultsareduetoluckorskill,
evenwithmorethanaten-yeartrackrecord.Everyerahasvalueinvestorswhocan
producegood,long-termresults.Today,Buffetthasa57-yeartrackrecord.Othershave
twentyorthirtyyearrecords.Withoutexception,thesepeopleareallvalueinvestors.
IfIwasintheaudiencetoday,Iwouldwanttofigureoutwhatisvalueinvestingand
understandhowtheseinvestorsobtainedtheirresults.WhenIfirstheardaboutvalue
investing,itwasBuffett’sfirsteverlectureatColumbiaUniversityandIhadcome
completelybyaccident.Theaudiencewasassmallasthisonetoday.Iwantedtofigureout
whatvalueinvestingwasandhowthesepeoplecouldcontinuouslyproducesuchgood
resultsinsuchachallengingenvironment.
TranslatedbyGrahamF.Rhodes,CFA Page16of37
Sowhatisvalueinvesting?ValueinvestingisasystemdevisedbyBenjaminGrahamwhich
firstbegantotakeshapeeightyorninetyyearsago.It’sleadingfiguretodayisnoneother
thanWarrenBuffett.Butwhatdoesitmean?Actually,it’sverysimple.Thereareonlyfour
principlesofvalueinvesting:threefromGrahamandonefromBuffett,hisunique
contribution.
First,stocksaren’tjustlittlepiecesofpaperthatyoubuyandsell.Eachoneisinfacta
certificatebestowingfractionalownershipofacompany.Thisisthefirstimportantconcept.
Whyisitimportant?Investinginstocksisactuallyinvestinginacompany.Andasthat
companygrowsalongwiththeeconomy,whenthemarketeconomycontinuestogrow,
valueitselfwillbecontinuouslycreated.Asfractionalownersofthatcompany,thevalueof
ourfractionwillgrowalongwiththevalueofthewholecompany.Soifweinvestasowners
ofabusiness,wewillbenefitasaproductofthegrowthinthevalueofthatbusiness.Thisis
sustainable.Whatistherightwaytoinvestandwhatisthewrongway?Therightwayisto
earnwhatyoudeserve.Sothiswayofinvestingistherightway.Veryfewpeopleare
willingtolookatstocksthisway.
Second,understandtheroleofthemarket.Stocksrepresentthefractionalownershipofa
businessbutontheotherhand,theyarealsotradeablesecuritieswhichcanbeboughtand
soldatanytime.Andinthismarket,thereisalwayssomeonequotingaprice.Howshould
weunderstandthisphenomenon?Valueinvestorsbelievethemarketisonlytheretoserve
you.Itcangiveyouthechancetobuyasmallpieceofabusiness.Andmanyyearslater
whenyouneedmoney,itcangiveyouawaytosellandturnthatsmallpiecebackintocash.
Thismarketcannevertellyouwhatthetruevalueofsomethingis.Itcanonlytellyouwhat
thepriceofsomethingis.Youmustneverletthemarketbecomeyourmaster.Youcan
onlyletitbeatooltoserveyou.Thisisthesecondveryimportantprinciple.Butpractically
95%ofmarketparticipantsunderstandtheopposite.
Third,investingisinherentlyaboutpredictingthefuture.Butpredictionscanneverreach
100%accuracy;theycanonlyfallbetweenzeroandsomethingapproaching100%.Sowhen
wemakeajudgement,weneedtoleavealargebuffer.Thisiscalledthemarginofsafety.
Becausethereisnowaytoeverbesure,youmustalwaysrememberthemarginofsafetyno
TranslatedbyGrahamF.Rhodes,CFA Page17of37
matterhowmanyotherthingsyougrasp.Thepriceatwhichyoubuyshouldalwaysbefar,
farbelowthecompany’sintrinsicvalue.Thisisthethirdimportantprincipleofvalue
investing.Becausewehavethefirstprinciple,weknowthatourstockisafractionalinterest
inacompany,andthatcompanyitselfhasanintrinsicvalue.Andbecausewealsoknow
thatthemarketistheretoserveus,wecanwaittobuyuntilthepriceisfar,farbelowthe
company’sintrinsicvalue.Andwhenthepricefar,farexceedsthecompany’sintrinsicvalue,
youcansell.Thiswayyouwon’tlosetoomuchmoneyifyourpredictionofthefutureis
wrong.Evenifyourpredictionproves80%or90%correct,youwillstillneverbe100%
correct.Andwhenthatremaining10%or20%probabilitymaterialisesandhasanadverse
impactontheintrinsicvalueofyourinvestment,youwon’tlosetoomuch.Andifyoudo
turnouttoberight,yourreturnwillbemuchhigherthanothers.Demandingahugemargin
ofsafetyeachtimeyouinvestisoneoftheskillsofinvesting.
Fourth,inhisfiftyyearsofpractice,Buffetthasaddedonemoreprinciple:through
unremittinghardworkoveralongperiod,investorscanbuilduptheirowncircleof
competence.Thiscangivethemadeeperunderstandingthanothersofacompanyoran
industry,andallowthemtomakebetterjudgementsoffutureperformance.Yourunique
strengthlieswithinthiscircle.
Themostimportantpartofthecircleofcompetenceistheboundary.Anabilitywithouta
boundaryisnotanability.Ifyouhaveapointofview,youmustbeabletotellmethe
[unsatisfiedconditions]forittobearealpointofview.Ifyoujustgivemeaconclusion,it
willalmostcertainlybewrongandunabletowithstandscrutiny.Whyisthecircleof
competencesoimportant?Becauseof‘Mr.Market’.Whatisthepointofthemarket?As
farasmarketparticipantsareconcerned,itistodiscovertheweaknessofhumannature.If
therearethingsthatyoudon’tunderstand,orifyouhaveanykindofpsychologicalor
physiologicalweakness,therewillbeasituationinthemarketwhichexposesyou.Anyone
who’sbeeninthemarketbeforewillunderstandexactlywhatI’mtalkingabout.The
marketisanaggregateofusall.Ifyoudon’tknowwhatyou’redoingthere,therewillbea
momentwhenthemarketknocksyoudown.Thisiswhyyouonlyeverhearstoriesabout
peoplemakingmoneyinthemarket.Butintheend,everyonelosesitall.Youonlyhear
storiesaboutnewpeoplemakingmoneybecausetheoldoneshavealldisappeared.The
TranslatedbyGrahamF.Rhodes,CFA Page18of37
marketcanseethroughyourlogicandallyourproblems.Ifyoustrayoutsideofyourcircle
ofcompetence,orifyourcirclehasnoboundaries,orifyoudon’tknowyourboundaries–
therewillbesomemomentwhenthemarkettakesyoutothecleaners.
Onlyinthissensedoesinvestingcarryrisk.It’snotthepriceofastockbouncingupand
down;it’stheriskofapermanentlossofcapital.Whetherthisriskexistsornotdependson
whetheryouhaveacircleofcompetence.Andthiscirclemustbeverysmallandverywell
defined.Onlywithinthistinycircleofcompetencewillyoubeablethroughhardworkto
makegoodpredictionsaboutthefuture.ThisisBuffett’sconcept.
ProfessorGraham’sinvestmentstylefoundcompanieswithnolong-termvalueorgrowth.
AndtheconceptofthecircleofcompetencearosefromBuffett’sownexperience.Ifyou
canreallyacceptthesefourbasicconcepts,thenyoucanbuildlong-termholdingsatlow
pricesincompanieswithinyourcircleofcompetence,andthroughthegrowthinthe
company’sownintrinsicvalueandthereturnofpricetovalue,youcanobtainlong-term,
goodandreliablereturns.
Togetherthesefourbasicconceptscomprisetheentiretyofvalueinvesting.Valueinvesting
isn’tjustsomethingthat’seasyandcleartospeakabout;it’salsotherightroadtofollow.
Therightroadisonethatissustainable.Whatissustainable?Sustainablethingsallhave
onethingincommon:fromtheperspectiveofothers,whatyoureceivehasallbeenfairly
earned.Ifyourmethodsofmakingmoneywerecompletelyrevealedtothepublicandthey
thoughtyouwereacheat,thenthosemethodswouldnotbesustainable.Ifontheother
handtheythinkyourmethodsaretrue,goodandadmirable,thenthosemethodsare
sustainable.Thisiswhat’scalledthe‘truepath’.
Whyisvalueinvestingtherightpathtofollow?Becauseittellsyouthatwhenyou’rebuying
shares,you’rebuyingpartofacompany.Investinghelpsthemarketvalueofthatcompany
comeclosertoitsintrinsicvalue.Youaren’tjusthelpingthecompanytocontinuouslygrow
itsintrinsicvalue;asthecompanygrowsandcreatesvaluewithinCivilisation3.0,itsintrinsic
valuewillgrow.Andthevalueofyourfractionalownershipofthatcompanywillgrow.And
atthesametime,youwillbegivingyourclientssomethingoflong-termbenefit:a
TranslatedbyGrahamF.Rhodes,CFA Page19of37
sustainable,reliableandsafereturn.Finally,theresultisyouwillhelptheeconomy,the
company,individualsandyourself.Earningreturnsthiswaywillmakeothersfeellikeyou’ve
deservedthem.Sothisistherightpath.Youwon'tbethrownoffcoursebytheupsand
downsofthemarket.Youwillbeabletoclearlyassessacompany’sintrinsicvalue.Youwill
haveadeeprespectforthefutureandknowtheuncertaintyinherentinprediction.
Therefore,youwilluseanappropriatemarginofsafetytomanagerisk.Thisway,youwill
notlosetoomuchwhenyouarewrong,andyouwillmakemuchmorewhenyouareright.
Thiswayyoucanletyourportfoliogeneratehigherthanmarketreturnswithlessrisk,ina
sustainableandstableway.
Ifyoustartwithnothing,takea2%commissionandthen20%ofprofits;andifyoulose,you
justcloseonecompanyandstartanotherthenextyear–whatwilleveryonethinkwhen
youtellthem?Willtheythinkthatwhatyoureceivediswhatyoudeserve?Orwillthey
thinkthatyoudeservetobeputinjail?ButifyoufollowBuffett’smethodofleavingabig
marginofsafetyandappropriatelymanagingrisk,everyonecanbeawinner.Andwhen
everyonewinsandyoucollectasmallfee,everyonewillfeelthatyouhavereceivedwhat
youdeserve.Thisistherightpathtofollowininvesting.
Thisisthesumofvalueinvesting.Itsoundseasyandlogical.Butwhataboutinpractice?
Thiskindofinvestorisfewandfarbetween.Everyinvestmenttheoryhasitsfollowersbut
therearevery,veryfewtruevalueinvestors.Consequently,oneofthecharacteristicsof
investmentisthatmostpeoplewillhavenoideawhatyouaredoing.Theresultcould
becomeharmfultoyourwealth.Thestockmarketcrashwejustwentthroughisagreat
illustration.
Sotherightpathininvestingisclearandfreefromanytraffic.Whereiseveryonegoing?
Thewrongway!Theyaretakingthewrongpath.Why?Becausetherightpathtravelsslow.
Itmaysoundlikeyoucanstrolltotheendbutthejourneyisinfactveryslow.Intheory,
valueinvestingappearslikesomethingwhichcanleadtosuccess.Butthejourneyisalong
one.Perhapswhenyoubuythemarketreallydoesn’tunderstandacompany’sintrinsic
valueandthepriceisfarbelowwhatitshouldbe.Butyouhavenoideawhenthemarket
willbecomemorereasonable.Andmuchdependsonthecompany’smanagementworking
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hardtobuildthecompany’sworth.Weallknowthatacompany’ssuccessdependsonalot
ofpeople,alotoftime,alotofhardworkandalittlelucktoo.Sothisisaverydifficult
process.
Makingpredictionsaboutthefutureisalsoverydifficult.Investingistheabilitytopredict
thefuture.Youreallyneedtounderstandacompanyanditsindustryandassesstheir
outlookforthenextfiveortenyears.Cananyoneheretellmeaboutacompanywhose
futuretheycanpredictforthenextfiveyears?Itisn’teasy.Beforeinvesting,weneedto
knowataminimumwhatacompanywilllooklikeintenyearsandhowitwillbehaveina
downturn.Otherwise,howcanyoujudgethatthevalueofthiscompanywon’tdecline?To
knowwhatacompany’sfuturecashflowsareworthtoday,wemustknowapproximately
whatthosecashflowswillbeintenortwentyyears.Asthefounderofacompany,howdo
youknowaboutnextyear?Yousayyouknowtoclientsandinvestors.Sometimesyoueven
saythistoyouremployees,thingslikeyourcompanywilljointheFortune500.Butthereis
nowayyoucanreallypredicthowyourcompanywilldevelopoverthenexttenyearsor
more.Thosewhocandosoarevery,veryfew.Therearetoomanyuncertaintiesformost
companiesandindustriestomakepredictionsthatfarout.Doesthatmeantherearenone
atall?Ofcoursenot.Afteralotofhardwork,youwillseewhichcompaniesandindustries
haveaclearpictureofwhattheycouldbecomeintheworstcase.Theywillprobablyendup
muchbetterthanthis.Butitwilltakeyearsofhardworkandstudytoreachthelevelwhere
youcandothis.
Andwhenyoucanmakethiskindofjudgement,youwillstarttobuildyourcircleof
competence.Atthestart,itwillbeverynarrow.Anditwilltakealongtimetoevenget
there.Thisiswhyvalueinvestingissuchalongandslowprocess.Althoughyouwillget
thereintheend,mostpeopleareunwillingtomakethejourney.Ittakesalotoftimeand
yetevenafteralotoftime,youmaystillnotknowverymuch.
Youwon’tgoonfinancialtelevisiontovalueallcompanies,immediatelytellothersthatthis
company’ssharepriceshouldbethat.Ifyouareatruevalueinvestor,youwouldnever
darespeakthisway.Youalsowouldn’tdaretosaythat5,000pointsistoolow,thatthe
greatbullmarketisjustabouttostartorthatyouwon’tstartbargainhuntinguntil4,000
TranslatedbyGrahamF.Rhodes,CFA Page21of37
points.Youcan’tsaythesethingsandwon’tdaretomakesuchpredictions.Ifyouareareal
investor,thesethingswillobviouslybeoutsideyourcircleofcompetence.Thosewhodraw
theircirclebeyondtheirabilitywillcompletelydestroythemselvesintheend.Themarketis
amechanismfordiscoveringyourweakness.Ifthereisanareayoudon’tcompletely
understand,youwillbefoundoutandyouwillcompletelydestroyyourself.
Themostfundamentalrequirementofthisprofessioniscompleteandutterintellectual
honesty.Youshouldneverfoolyourselfbecauseyouarethemosteasilyfooled,especially
inthisprofession.Youcantalkbullshittootherpeopleandeventuallyendupbelievingit
yourself.Butthiskindofpersoncanneverbecomeanexceptionalinvestor.Theywill
withoutadoubtcomeundoneinacertainkindofmarket.That’swhyourprofession
basicallycannotproducemanyexceptionallongterminvestors.We’vetalkedtodayabout
manyso-calledstarinvestorswith20%CAGRsearnedovertenormoreyears.Butinthe
finalyeartheycloseshopafterlosingtensofpercentagepoints.Whentheystartout,their
assetsaresmall.Butwhentheylose,theirassetsarelarge.Andsowhattheyloseisfar
morethanwhattheyevermade.Yettheymakealotofmoneyforthemselves.Ifwe
countedfrombeginningtoend,theyreallyshouldn’thavemadeadollar.Thisistheunique
partoftheindustrythatwetalkedaboutearlier.
Soeventhoughthisistherightroadtofollow,successisstillalongwayoff.Manypeople
areputoffbythis.Inaddition,themarketwillalwaystemptyouwithshorttermprofits.
Yourcanhavebigchangesinyourassetsoverashortperiod,givingyoutheillusionthatyou
canearnalotofmoneyinashortperiodoftime.Soyouwillbecomeinclinedtospendyour
timeandenergymakingshorttermmarketforecasts.Thisiswhyeveryonewillinglystarts
takingshortcuts,andisn’twillingtofollowtherightpath.Andalmostalltheseshortcuts
turnouttobedeadends.Becausealmostallinvestmentstyleswhichfocusonshortterm
tradinglosemoneyoveralongenoughtime.Notonlywillyouloseyourclients’money,you
willloseyourown.Therefore,atleastinAmerica,weseeveryfewsuccessfullongterm
trackrecordsfrominvestorsofallstripeswhofocusonshorttermtrading.Andofthose
withreal,exceptionallongtermtrackrecords,virtuallyallarevalueinvestors.
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Shorttermresultsoftenbenefitfromluckandhavenoconnectionwithskill.Forexample,
takeashortperiod,notevenoneortwoyearslong.Atanytime,evenoneortwoweeks,
therewillalwaysbesomerockstars.Idon’tevenknowhowmanyrockstarsemergedin
Chinaoverthelasteightmonths.Manycametoaverybadend.Intheshortterm,there
willalwaysbewinnersandlosers.Butinthelongterm,thereareveryfewwinners.One-,
two-orthree-yeartrackrecords–eventhreetofiveyear,orevenfivetotenyeartrack
records–areseldomanyuseforpredictingfutureresults.Ifsomeonetellsmethey’vehad
goodresults,sayoverfiveortenyears,ifIcan’tseetheiractualinvestmentresults,Istill
won’tbeabletojudgeifit’sdowntoluckorskill.Thisisoneofthecoreproblemsjudging
valueinvesting:isitluckorisitskill.
Themarketcandeliver14%CAGRsoverconsecutiveperiodsoffifteenyears.Inthosetimes
youdon’thavetobeagenius;it’senoughjusttobethere.Butthereareothertimeswhen
returnsarenegative.Havingagoodtrackrecordinthoseyearsisnotthesame.Soit’svery
hardtojudgeperformancewithoutseeingthecontext.Butifsomeonecanproduce
outstandingreturnsoverfifteenyearsormore,thenwecanprobablysaythey’resomething
exceptional.It’ssafetosaythere’smoreskillthanluckoverthattime.Butthisalsomeans
thatinthisprofession,ittakesyearsofhardworkbeforeyoucanpossiblyidentifytalent–
anditcanbeupwardsoffifteenyears.That’swhyalthoughthisroadleadstosuccess,there
aresofewpeoplewhofollowit.Butthisisexactlytheopportunityforthosewillingtoface
hardworkandalongjourney.Astheyprogress,thesuccessthattheyearnisseenby
everyoneaswelldeserved.Thisistheonlykindofsuccesswhichissustainable.Your
successwillbearesultofwhatyouputinandeveryonewillbeabletoseethisobjectively.
Ihopeallthestudentsheretodaycanresolvetofollowthispathandearntheirsuccessin
thisway.Youwillalsofeelcomfortablethisway.Youwon’trelyonshorttermgamesto
turnyourclients’moneyintoyourmoney.Ifyouenterthisindustrybutdon’tpossessthe
moralbottomlineItalkedaboutearlier,intheprocessofbecomingsuccessful,youwill
definitelygivethepublicopportunitiestodestroytheirwealth.Itwillbeacrime.Iremind
everyone,especiallythosestillstudyingandthinkingofjoiningtheindustry,toaskyourself
honestlyifyoucanbeagoodfiduciary.Ifnot,Iurgeyounottojointheindustry.Itwillbe
harmfultosociety.Ofcourse,youmaygetrichalongtheway.Idon’tthinkIcouldsleep
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wellifitwasmebutofcourse,lotsofotherpeoplecan.Ihopethatyouaren’tthatkindof
personandthatifyoujointheindustry,youwillnotdothesekindsofthings.
Ifyouareoneofthosepeoplewithoutthefiduciarygeneandyoustilldoentertheindustry,
youwillultimatelyfinishinadeadend.Alltheshortcutswillendinabadwayandyouwill
takeyourclients’moneywithyou.Ifyouarenottoosmart,theonlyresultwillbethatyou
willloseallyourmoney.Ifyoudonottreatthepursuitofknowledgeasamoral
requirement;ifyoucannotcultivatethefiduciarygene;ifyoucannottreateverybitofclient
moneyasthoughitwasmoneythatyourparentshadscrimpedandsavedtheirwholelives
toearn;Iurgeyounottojointhisindustry.
SoIhopethateveryoneenteringthisprofessionletstheseprinciplestakeroot,andfollows
therightpath.
4. IsValueInvestingpracticableinChina?
Inwhatfollows,Iwilltalkaboutthefinalquestion:sinceValueInvestingisa‘truepath’,can
itbepracticedinChina?
Overthelastfewhundredyears,equityinvestinghasindeedgiveninvestorsgreatbenefits
overthelongterm.We’veexplainedwhy,whytheseconditionshaven’tbeenpresent
throughouthumanhistoryandhowtheyonlymaterialisedinthelastthreehundredyears.
Mankindenteredanewera,whichwecallmodernityandwhichIcallCivilisation3.0.
Modernscienceandtechnologyhavecombinedwithafreemarket.SoisChinaaspecial
case?IsitonlyAmericaandtheEuropeancountrieswhichcanproducetheseconditions?
ManypeoplehaveconcludedthatChinaisanexception,withmuchthatisdifferentfrom
America.Butforthepurposesofourdiscussiononinvestment,isChinareallyaspecialcase?
Ifmostpeoplearespeculating,priceswillatmanytimesdivergefromintrinsicvalue.So
howcanyoudetermineifChinawilloverthenextfewdecadesfollowthepathofthe
Americaneconomyandstockmarket?Ifbadmoneychasesoutthegoodmoney,pricescan
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indeedgoagainstfundamentalvalueforalongtime.Howlongissufficientfor‘longterm’?
Howcanweguaranteeourfinancialassets?AndwhatifChinadoesnotimplementa
marketeconomy?Answeringthesequestionswillbecritical.Theytouchonourforecasts
forthenextseveraldecades:whatwillChinabelike?
Ihavepersonallyspentmanyyearspuzzlingoverwhethervalueinvestingcansucceedin
China.InvestinginaChinesecompanymeansinvestinginChinaitself,andthiscountry
couldwellseeayearlike1929or2008.Infact,manypeoplebelievethatthisyearwehave
alreadyencounteredsimilartimes,andthatoverthenextfewmonthswemayseemore.If
youinvest,youwillalwaysfacesuchquestionsinthemarket.Beforeyoudoanything,you
mustcarefullythinkovereveryproblem.Thisquestionisunavoidableandmustbe
addressed.
Wewillfirstusestatisticsagain.IhavecollectedwhatdataIcantocomparethe
performanceoftheChinesestockmarketagainstotherassetclasses.Figure5showsthe
performanceofAmericanassetsfromtheendof1991untiltheendoflastyear.Wecansee
thattheirperformanceisalmostthesameasoverthelasttwohundredyears.Stockshave
continuouslygainedvaluewhilecashhascontinuouslylostvalue.Thisisbecauseofthe
continuousgrowthinGDP,thesameasithasbeenoverthelasttwohundredyears.
Figure5:PerformanceofmajorAmericanassetclassesfrom1991-2014
TranslatedbyGrahamF.Rhodes,CFA Page25of37
NextwewilllookatthestatisticsforChina.The“Original8”onlylaunchedinChinain1990
andthefirstrealindexin1991.I’dliketoinviteeveryonetoguesswhatChinawaslikein
thosedays?WeknowthattheChinesestockmarkethasbeenonarollercoasteroverthe
lastthreemonths.Didstocksbehavethesamewayinthepast?Let’slookatFigure6.
Figure6:PerformanceofmajorChineseassetclassesfrom1991-2014
WhatweseeisthattheresultsinChinahavebeensimilartoAmerica’soverthelasttwo
hundredyears.From1991untiltoday,onedollarofcashhasbecome47.3cents,thesame
asinAmerica.Goldhasbeenthesame,ofcourse.TheShanghaiandShenzhenindiceshave
appreciatedsteadily.Fixedincomehasalsoappreciated.ButthedifferenceisthatChina’s
GDPhaschangedmaterially.Asaresult,thechangeinstockpricesandindicesismorein
linewiththeperformanceofGDP.Inotherwords,higherthanAmerica’s.Thisisaspecial
patternweseeinthisemergingmarket.Whatwehaveseenisthatoverthelastfew
decades,thebasicresulthasbeenthesameasAmerica’sandthatGDPgrowthhasbeenthe
samedrivingforce.Asadirectresultofhighinflation,cashhasdepreciatedandstockshave
appreciatedatahigherrate.Otherwise,thebasicresultisthesame.Thisisveryinteresting.
TranslatedbyGrahamF.Rhodes,CFA Page26of37
Figure7:ComparisonofAmericanandChinesestockindicesfrom1992tothepresent
Figure8:GDPgrowthinChina,AmericaandHongKongfrom1991-2014
WecanseethatoverthelasttwodecadesChinahasstartedthepathtowardsCivilisation
3.0andthatitsperformancehasbeenlikeAmerica’s.Yetwhilethetrendissimilar,the
speedhasbeenfaster.However,whiletheShanghaiandShenzhenindiceshaverisen15
times–anannualisedgainof12%–Idonotthinkthatanyonehasindividuallyenjoyedthe
sameresult,includingthoseinvestorssittingheretoday.Yetthereissomeonewhohas
earnedthisreturnfromthedaythestockmarketwasestablished:theChinesegovernment.
EveryoneworriesaboutthehighdebtlevelinChinabuttheyoftenforgetthattheChinese
governmentisthemajorshareholderinjustabouteverycompany.Noneofthestock
marketpuntershaveachievedthesameresult.NooneknewattheoutsetthatChinawould
enjoyalmostthesameperformanceasAmericabecausetheroadwetravelledwasnotthe
same.ButtheresultsarethesamewhenyouadoptmodernityandCivilisation3.0.
Haveindividualcompaniesalsobeenlikethis?I’vechosenseveralfamiliarcompaniesto
illustrate:ChinaVanke,GreeElectricAppliancesofZhuhai,FuyaoGlassIndustryGroup,
StatePowerandKweichowMaotai.Theyhaveallgrownfromhumbleoriginstotheir
currentsize,appreciatingbetween300and1,000times.
TranslatedbyGrahamF.Rhodes,CFA Page27of37
Figure9:PerformanceofselectedA-sharecompaniesfrom1991topresent
Hasanyonemademorethanathousandtimesonaninvestmentinthelasttwentyyears?
YouwouldhaveifyouhadinvestedinChinaVanke.Ofcourse,onlythepre-IPOstate
shareholderwasabletobecausethecompanypoppedtentimesonitsfirstdayoftrading.
Soit’sworthdenotingthispre-IPOphenomenon.Afterthefirstday,everyonecaninvest;if
youhadboughtthen,youstillcouldhaveearnedjustabout100timesforVankeand110
timesforInnerMongoliaYiliIndustrialGroup.Thisisn’tabstract;thesecompaniesareall
real.Theyallgrewfromverysmallcompaniesintoverylargecompanies.
ItwasthesameinHongKong.IfyouhadinvestedinTencentHoldings,youcouldhave
earned186times.Andthatcompanyonlylistedtenyearsago,in2004,whichisnotsolong
ago.ThesecompaniesalldoalotbusinessinChina(refertoFigure10).AnhuiConch,China
EverbrightInternational,HongKongExchangesandClearing,Li&Fungetc.It’snotonly
thesecompanies;thesearejustoneswithwhichmostofyouareprobablyfamiliar.Ijust
usetheseasexamplestoshowyouthatit’snotanabstractidea.
TranslatedbyGrahamF.Rhodes,CFA Page28of37
Figure10:PerformanceofselectedH-sharecompaniesfrom1991topresent
AtthesametimeorearlierinAmerica,thereareafewcompaniesthathaveachieved
similarreturnswithwhicheveryoneshouldbefamiliar.BerkshireHathawayhasreturned
26,000timesfrom1958untiltoday.ManyofthebestperformingcompaniesinAmerica
havealmostbeenChinesecompanieslikeBaiduandCtrip(refertoFigure11).
TranslatedbyGrahamF.Rhodes,CFA Page29of37
Figure10:PerformanceofselectedUS-listedcompaniesfrom1991topresent
I’mnottryingtohighlightanyspecificcompany.Ijustwishtoprovethatgoodreturnslike
theseexist.Stockindicesaren’tabstractthings;theyareconstitutedofindividual
companieslikethese.We’vegonedownmanyroadsoverthelasttwohundredyearsbut
oncewechosetoheadtowardsCivilisation3.0,theresultshavebeenalmostthesameas
othercountries.
Howdoyouexplainthisphenomenon?Howshouldweunderstandtheperformanceofthe
lastfewdecades?Mostimportantly,willtheChinesestockmarketproducesimilarresults
overthenextfewdecades?Whetherit’sthesamecompanyornot,willitgiveyouanother
100to1,000timesreturn?Doesthispossibilityexist?Thisisthefinalquestionwewill
answertoday.
WemustdeterminewhetherChinaisuniquebyexaminingthewholeprocessofits
modernisation.China’smodernisationbeganin1840whenitwasmadetomodernise;this
wasn’tapro-activedecision.Chinaneverwouldhavetakenthisfirststepifithadbeenleft
toitsowndevices.TheprimaryreasonisthattheChinesestatewastoostrongandnever
gavespacetoallowamarketeconomytodevelop.TherewereseveraltimesinChinese
historywhenamarketeconomyalmostblossomedbutitcouldneverreallytakeroot.From
theHanDynastyonwards,theChinesestatehasbeentheworld’smoststable,mostbig,
mostpowerfulandmostprofound.ThisisrelatedtoourgeographybutIwon’tgointothat
today.Themostimportantthingisthatbecausethiscountryhasbeenexceptionallystrong
andstableoverthelasttwothousandyears,itcouldnevergivebirthtoCivilisation3.0.But
thatdoesn’tmeanCivilisation3.0couldn’tbeforceduponit.
Themodernisationweseetodaywasn’tasimplemodernisationofoursystemasthe
changessince1840areoftenunderstood.Itwasn’taculturalchangeorachangeinthe
economicsystem.Itwasachangeincivilisation.
Thischangeincivilisationisakintotheagriculturalrevolutionseen9,000yearsBC.That
revolutioncameaboutthroughaccidentalfactors.Afterthelasticeageendedinthe
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MiddleEast,agriculturebecamepossible.IntheFertileCrescent,therewerewildplants
whichcouldbefarmedandwildanimalswhichcouldbedomesticated.Andonce
agriculturehadtakenrootthere,itquicklyspreadtoeverycorneroftheworld.Today’s
Civilisation3.0isanovelcombinationofamarketeconomywithmodernscienceand
technology.AsCivilisation3.0haspropagatedoverthelasttwohundredyears,wecansee
manysimilaritieswiththepropagationofCivilisation2.0.
TheriseofCivilisation3.0resemblesthatofCivilisation2.0:almosteverythingboilsdownto
asetoffortuitousincidentscreatedbygeography.Nothingwasinevitable.Becauseofits
location,WesternEuropewasthefirsttodiscovertheAmericas.TheAmericasareonly
3,000milesfromWesternEuropebutmorethan6,000milesacrossthePacificfromChina
andpracticallyspeaking,closerto9,000milesduetooceancurrents.Chinawasalsonot
motivatedtogototheAmericas.Followingthisdiscovery,atrans-Atlanticeconomy
emerged.Themostspecialpartofthiseconomywasthatthegovernmentwasnotinvolved.
Itwasonlyundertheseconditionsthataneweconomicmodelcouldemergebasedonthe
absenceofgovernment,freeenterpriseandtheprimacyoftheindividual.Thiseconomic
modelchallengedmankind’sworldviewandinresponseprovokedmodernscience.Modern
scienceinturnbroughtitsownrevolution,re-examiningancientknowledgeandsparking
theEnlightenment.Itwasonlywiththisbackgroundandundertheseconditionsthat
Civilisation3.0couldbeformed.
TheseconditionscouldneverhavematerialisedinChinesesociety.Butaswesawwith
Civilisation2.0,onceanewmodelappears,itwillrapidlyspreadaroundtheworldto
supplanttheoldmodel.Thishastodowithhumannature.Perourunderstandingof
ancestralbiology,mansharesacommonnature,ancestorsfromacommonlocationand
fromacommonspecies.ManbeganhisexodusfromAfrica50or60thousandyearsago
andtookabout35thousandyearstospreadaroundtheworld.Hislinefollowedmany
differentpaths,onebranchofwhichbecameEurope,anotherChinaandfinallyonce
coveringtheAmericancontinent.Asaresult,humannatureisevenlydistributed,whether
itisintelligence,enterpriseorcompassion.[Asaspecies,mankindseeksanequalityof
outcomesandacceptsanequalityofopportunities.]Seekinganequalityofoutcomesspurs
moreadvancedmodelsofcivilisationtorapidlypropagatearoundtheworld.[The
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mechanismforacceptinganequalityofopportunitiesspurseachsocietytohaveitsown
cultureandcreateitsownsystems,andtoletthempenetrateintoeventhemostbackward
ofplaces.]Butthisprocessfrominequalitytoequalityisaverypainfulone.
Sothepropagationofcivilisationwillhappensoonerorlater.Placeswitharelatively
advancedcivilisationandculturewillassimilatequicker.Thosewithoutahistoryof
colonisationwillalsobefaster.ThisiswhyJapanwasthefirstcountryinAsiatomodernise.
ChinahasfollowedbutIndiahasbeenslowerbecauseitwasfullycolonised.
Wewon’tgointothosedetailsnowbutsufficeittosaythatChinahasbeenundergoingthe
processofmodernisationsinceabout1840–buthasneverfullyunderstoodthenatureof
modernity.Since1840,wehavetriedjustabouteverymethodthereis.Theearliestwas
theSelf-StrengtheningMovementwhichbelievedthatitwouldbeenoughtolearnWestern
scienceandtechnology,andtoleaveeverythingelseasitwas.Itdidn’tworkandwesaw
theTaipingRebellionandtheJapaneseOccupation.ChinanevertriedtoemulateJapan’s
pathtomodernity,largelybecausewebelievedthatwemustdothecontrarytowhatever
roadtheyfollowed.Inthefirstthirtyyearsafter1949,wefollowedyetanotherpath,the
collectiveeconomy,awhollyplannedeconomicsystem.Wehavemoreorlesstried
everythingonce.Thenfromtheendofthe1970s,wefinallytriedsomethingwhichwould
bringustoCivilisation3.0:afreemarketcombinedwithmodernscienceandtechnology.
Wehadtriedeverythingelseoverahundredandfiftyyearsupuntilthatpointwithout
success.Thepoliticalsystemhasnotseengreatchangeandnorhasourculture.Butinthe
last35years,China’sentireeconomicsystemhassuddenlybecomeamazinglyconsistent
withthatofCivilisation3.0.
Inotherwords,ChinatrulyenteredCivilisation3.0inthelast35years.Priortothis,our
pathtomodernityovertheprevious150yearswastortuous.Therearemanyreasonswhy
butweneverwereheadingintherightdirection.
Itwasonly35yearsagothatwe[returnedto]theessenceofCivilisation3.0,thefreemarket
economyandmodernscienceandtechnology.Butassoonaswestarteddownthispath,
theperformanceoftheChineseeconomyhasshownastrikingsimilaritytootherCivilisation
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3.0economies.Aswe’vejustseeninthetableabove,overthelast20and30years,the
performanceofstocksandcompanieshasbeentrulyamazing.WhenChinabeganto
resembleCivilisation3.0,thewayitmanifesteditselfwasvirtuallythesameasother
Civilisation3.0countries.Sointhisrespect,Chinaisnotunique.WhereChinaisuniqueis
thatitscultureandpoliticalsystemaredifferent.Butaswe’veseen,thesearenotthe
essentialelementsofCivilisation3.0.
CanChinadeviatefromthispath?BecauseChina’spoliticalsystemisdifferent,many
foreignanddomesticinvestorshavedeepsuspicions.Afterall,Chinahashadthisformof
politicalsystemforalmosttwohundredyearsandhastestedmanydifferentdirections
towardsmodernity.Couldweheadinreverse?
Weknowthatinthefirstthirtyyearsafter1949,Chinaconfiscatedprivatepropertyand
pursuedcollectivisation.Itcoulddosobecauseofourpoliticalsystem.Couldwedoan
aboutfacenowandabandonthemarketeconomy?Thisisaquestionthatinvestorsmust
considercarefully,otherwiseitisextremelydifficulttopredicttheprospectsofCivilisation
3.0inChinaandthepotentialsuccessofvalueinvestingtherein.Ifyoucan’tanswer,or
thinkaboutitclearly,orareunsureinyourheart,themarketwillexposeyou.Onlyifyou
aren’tclearwillyoumakeamistakeandbeshakenout.
Thereisnouniformanswertothesequestions,andtheyhavebeenporedoverby
generationaftergenerationofintellectualsoverthelasttwohundredyears.Thequestions
I’vesharedtodayaremyown,andaresomethingI’vepuzzledoverfordecades.
Mythoughtsareasfollows.WemuststudytheironlawsofCivilisation3.0.We’vealready
madeasuperficialstudyofhowCivilisation3.0candeliversustainable,longtermand
continuouscompoundeconomicgrowththroughfreeexchangeproducingaddedvalue.
Scienceandtechnologyservetoacceleratethisprocess.Asmorepeopleandmore
countriespartakeinthiskindofexchange,thevalueaddedtheycreatebecomesgreater
andgreater.ThiswasAdamSmith’sinsightanditwasextendedbyRicardotoincorporate
tradebetweencountriesandeconomicsystems,therebylayingthefoundationforfree
trade.Anaturalfollow-onconclusionfromthesetheoriesisthatscaleadvantageswill
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emergeinlargermarkets.Andthankstothesescaleadvantages,largermarketswill
graduallycompeteawaysmallermarkets.Thatistosay,eventually,thelargestmarketwill
becometheonlymarket.
ThiswouldhavebeenunimaginableunderCivilisation2.0.Freetradewasaresultofthese
insightsandwithouttheseinsights,therewouldcertainlynothavebeenanyfreetrade–not
tomentiontheglobalisationwhichfollowed.Thefinalproofofthisprocesswhichbegan
withtheBritishinthe18thand19thcenturiesonlycameatthestartofthe1990swiththe
firstemergenceofglobalisation.Lookingbackfromtodaytotheemergenceofglobalisation,
wecanderiveanewinference:whentwodifferentsystemscompete,andoneisadding
valueatarateof‘1+1>2’whiletheotherisaddingvalueattherateof‘1+1>4’,thepace
ofaccumulationinthelatterwilleventuallybesogreatthatitbecomestheonlymarket.
Thishadneveroccurredthroughouthistoryuntiltheearlytomid-1990s,andwillnever
happenagain.Ricardobelievedthatwhentwopartiesengagedintrade,bothwouldbe
betteroff.Thiswasthecaseforfreetrade.Butheneverexpectedthattheprocesswould
resultinallmarketsultimatelybecomingasingleglobalmarket–thelargestmarketbecame
theonlymarket.Thisiswhatultimatelytranspiredinthemid-1990s.
Thishasbeenpreciselythetrendofhistoryoverthelastfewdecades.Inthebeginning,
therewasthetrans-AtlantictradebetweenBritainandAmerica.Theytookthisconceptof
tradeandpusheditontotheircolonies.Theyfoughtthetwoworldwars.Andafterthe
secondworldwar,twodistinctbutclosedeconomicblocstookshape,onecentredaround
theUS,WesternEuropeandJapan;theotheraroundtheSovietUnionandChina.The
formerwasobviouslylargerandbecameevermoreefficientbecauseitsubscribedtothe
principlesofthemarketeconomy.Thetwoblocswerewellmatchedtobeginwithbutafter
severaldecades,youcouldseeagapbetweenAmericaandtheSovietUnion;agapbetween
WestandEastGermany;agapbetweenmainlandChinaandHongKongandTaiwanetc.It’s
thesamekindofgapthatweseetodaybetweenSouthandNorthKorea.Theresultwas
thatintheearly1990safterthecollapseoftheBerlinWallandChina’sembraceofamarket
economy,wesawforthefirsttimeinhumanhistorytheemergenceofanewphenomenon
calledglobalisation.ThisiswhenthenatureofCivilisation3.0becametrulyevident.Icall
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thisanIronLawofCivilisation3.0:aglobal,unifiedandcommoneconomicsystemwithfree
trade,freeexchangeandfreemarketsatitsheart.
Marketsenjoyeconomiesofscale:asthenumberofparticipantsandexchangesincrease,
themoreincrementalvaluewillbecreated.Themoreefficienttheallocationofresources,
themoreproductive,wealthyandsuccessfultheeconomywillbecome,andthemoreableit
willbetoproduceandsupporthigh-endtechnology.Betweentwocompetingmarkets,the
largermarketwilleventuallybecometheonlymarket.Andanyperson,industryorcountry
whichleavesthelargestmarketwillregressandultimatelybeforcedtore-join.Thebest
wayforacountrytoincreaseitsstrengthistolowertariffsandjointheglobaleconomy.
Thebestwayforacountrytofallbehindistoshutitselfoff.Throughthemarket
mechanism,modernscienceandtechnologywillcontinuetoadvance,andcostswill
continuetodecline.Combinedwithmankind’sinsatiabledemand,theeconomywill
continueitscumulativegrowth.Thisistheessenceofmodernity.Afterthisphenomenon
emerged,wecouldunderstandthegapbetweenEastandWestGermany;betweenNorth
andSouthKorea;andbetweenpre-reformChinaandHongKongandTaiwan.WhydidIran
giveupitsnuclearweaponsprogramme?Tore-jointheglobaleconomy,theonlyeconomy.
AcountryassmallasIrancouldnotsustainadvancedtechnologieswhilesealedofffromthe
world.AndifyouthinkIranisn’tagoodexample,howaboutChina?OrifnotChina,then
howabouttheSovietUnion?
Thespeedofnewinformationisnowsuchthatweaccumulateinjustafewyearsthesum
totalofeverythingthatcamebefore.Inthelastdecade,thispacehadusdoublingevery
eightyears.Inthenextdecade,Ithinkitwillacceleratefurther.TheIronLawof‘1+1>4’
willcontinuouslyrepeatandataneverfasterspeed.Smallmarketswillfallbehind.China
hasalreadybeenamemberoftheWorldTradeOrganisationfor15years,andbeforethis
hadalreadyhadamarketeconomyfor20-30years.Inthisenvironment,anyeconomic
systemwhichchoosestostandalonewillinshortorderbecomearelativelysmallmarket,
andwillinevitablyfallfurtherandfurtherbehind.IfChinachangestherulesofitsmarketor
leavesthecommonmarket,itwill,inarelativelyshorttime,rapidlyfallbehind.Iam
confidentthatinacountryasmature,historicallysuccessfulandculturallyadvancedas
China,thiswouldnotbeacceptabletomostpeople.It’snotthatthereisnochancethat
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Chinawon’tleavethisbigmarketforbriefmoments;it’sjustthatChinaisunlikelytobea
loserforever.Chinesepeoplewillnotwillinglyloseafterexperiencingseveralmillenniaof
success.SoiftherearebriefmomentswhentheydeviatefromthepathofCivilisation3.0,
theywillquicklymakeamendsandcomeback.
However,whilethesedeviationsmightlooksmallinthelongcourseofhistory,theymight
berelativelylonginthecourseofourownlives.Butinthisstretch,therecanstillbefree
marketsandwecanstillfindasufficientmarginofsafety.Wecanenduretheseperiods.
[Theseperiodsarenomorescarythanthecontinuousmarketlowswehaveseenoverthe
lastdecade].Whenyouholdthistobetrue,yourunderstandingoftheIronLawof
Civilisation3.0willstillallowtoinvestwithasufficientmarginofsafety.
Withthesereasonsinmind,let’scomebacktotheprospectsforvalueinvestinginChina.
IthinkthatChinaistodaysomewhereinbetweenCivilisation2.0and3.0;let’scallit
Civilisation2.5.We’vealreadycomealongwaybutthereisstillalongwaytogo.Ibelieve
thatthereisahighprobabilitythatChinawillcontinuealongthiscoursebecausethecostof
notdoingsoisveryhigh.IfyoureallyunderstandthehistoryoftheChinesecultureandthe
Chineserace,especiallysincetheyhavecometounderstandthenatureofmodernity,then
youwouldappreciatetheprobabilityofthemreversingcourseisverylow.Theprobability
ofChinaleavingtheglobalcommonmarketispracticallyzero.TheprobabilityofChina
movingawayfromamarketeconomyisalsoverylow.Therefore,theprobabilityofChina
remainingintheglobaleconomyandcontinuingtoimplementafreemarketeconomyand
moderntechnologyisveryhigh.Andwe’veseenthattherelationshipbetweenCivilisation
3.0andpoliticsorcultureisnotverystrong,whiletherelationshipbetweenCivilisation3.0
andfreemarketsandmoderntechnologyisverystrong.Thisisthebiggest
misunderstandingmostinvestorshaveofChina,especiallyWesterninvestors.
Chinawillonlybeabletodeliverreturnsinitsmajorassetclassessimilartothehistoric
returnsseenindevelopedmarketsoverthelast300yearsifitcontinuesdownthepathto
Civilisation3.0andpersistswithfreemarketsandmodernscienceandtechnology.Ifitdoes,
theeconomywillcontinueitscumulativegrowth,creatingtheinflationwhichwillsee
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equitiesoutperformotherassetclasses.Andvalueinvestingwillofferthesamepromiseas
inAmericatodeliverclientssustainable,stable,safeandreliableinvestmentreturns.Thisis
theprimaryreasonwhyIbelievevalueinvestingcanbepracticedinChina.
Ibelievethatvalueinvestingisn’tlimitedtoChina,eventhoughinitspresentimmature
stageChinadoesoffervalueinvestorsmanyadvantages.AcrossChina’scapitalmarkets,70%
ofinvestorsarestillretailinvestorswhofocusonshorttermtrading.Eveninstitutional
investorsstillfocusonshorttermtrading.Priceswilloftendeviatewidelyfromintrinsic
valueasaresult,creatinguniqueinvestmentopportunities.Ifyoucanavoidbeingconfused
bytheseshorttermtradesandreallypersistwithlongtermvalueinvesting,youwillhave
fewcompetitorsandyourchancesofsuccesswillbemuchhigher.
Chinaiscarryingoutatransformationofitseconomytoallowfinancialmarketstoplaya
greaterroleinfinancing.Indirectbankfinancingwillnolongerbetheprimarysourceof
capital.Instead,theequityandfixedincomemarketswillbecometheprimarysourceof
capitalandthemaintoolsforcapitalallocation.Thescale,institutionalisationandmaturity
ofthecapitalmarketswillallbelifted.Ofcourse,ifyoulimityourselftowhat’sinfrontof
youreyes,youmightcomplainaboutthegovernment’sexcessiveinterventioninthemarket
anditsinjustice.However,Ibelievethatifyoulookfurtherout,China’seconomyisstill
headinginadirectionthatwillseetheroleofthemarketincrease,withmoreinstitutional
investingandagreatermaturity.Thesewillallplayanimportantroleinthenextstageof
development.Truevalueinvestorswillserveanevergreaterpurpose.
Soseeinghowyoungeveryonehereistoday,Ifeelalittleenvyinmyheart.Ibelievethatin
yourtime,asvalueinvestors,youwillcomeacrossmoreopportunitiesthanIhaveleft.I
feelveryluckythatinthelasttwentyyearsIcouldstudyvalueinvestingunderthetutelage
ofthegreatmasters,andtolearnandpracticeundertheirwatch.Youwillbeevenluckier.
ButIstillhopethateveryonecanalwaysholdontothefeelingyouhavenow,andalways
rememberthetwomoralbottomlines.First,alwaysunderstandyourfiduciaryduty.Treat
clients’moneyasyourown.Treatitasthenesteggthatyourparentssweatedandslaved
theirwholelivestoearn.Onlythenwillyoubeabletomanageitwell.Second,youmust
makethepursuitofwisdomandknowledgeyourmoralresponsibility.Youmustconsciously
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distinguishbetweentherealandfalsetheoriesinthemarkettopursuetrueinsight.And
onlythroughhardworkoveralongperiodoftimewillyoubeabletosucceedandearnthe
returnswhichyourclientsdeservetoearn.Andinthisyouwillbeabletomakeyour
contributiontothedevelopmentofChina’seconomyduringthistransformativeperiod–a
win-win-winforthecountry,yourfamilyandyourself.
Isincerelyhopethateveryoneherecanboldlygoforwarddowntherightpath!Theroadis
clearandthesceneryisespeciallynice.Don’tbelonelybecausethisprofessionisfullof
everykindofcuriosity,challengeandlandscape.Ihaveconfidencethateveryoneherewill
haveagoodfuture.Ifyoupersistforfifteenyears,youwilldefinitelybecomeoutstanding
investors!Thankyou!