“How much return did you make this year?” is the most frequently asked question at the end of each year, but rarely investors are asked about the risks they take to earn the profits. Human brains are prone to cognitive biases. People accept what can obviously be seen and often ignore the underlying risks. Investment profit is easier to be identified, so it is more likely to be the focus of investment measurement. On the other hand, investment risk, which is equally a key to each investment, are frequently overlooked because they are not so readily observable.
Each investment has potential risks and returns. A profitable result doesn’t mean it has no risk. It is just because risks have not been manifested this time. If the risks of an investment are high, they will inevitably materialize at some point. For instance, when betting in casino, it is possible to win three times in a row and make a profit of 300%, but you cannot win in long-term because the winning odds is low and the risk of losing money will be realized at some point. We make a lot of investments throughout our lifetime. The returns we eventually accumulate are the result of potential returns minus potential risks associated with each investment. Thus, it is important not to only search for the high potential gains, but to look for investment opportunities that have high risk-return ratio.
However, human brains tend to ignore potential risks and pay too much attention to returns, especially to those with very high potential profits. People naturally choose investments with higher potential returns, instead of those with the higher risk-return ratio. Stock investment decisions are often influenced by the advice of securities firms, friends, and family members. However, the problem of this approach is that when the demand for a favorable stock become high, it will drive up the stock price with reflection of the optimism of majority investors. Is this still a good investment in terms of risk-return ratio?
The stocks we invested are often with split views and often are not expected to succeed by the majority investors. With in-house research, we analyze majority misconceptions of overt pessimism. When we are correct, we can capitalize on our findings, and when we are incorrect, we bear low risks as the stock price has already reflected the pessimistic or negative outcoming and does not have much room to drop. This put us into a favorable/high risk-return position, which either makes a lot when we are right, or loses little when we are wrong.
We try to find investment opportunities with low risk and high risks-return ratio, so that the drawdown of our performance is limited. This can help client get a peace of mind and hold investment longer. The performance of many equity funds fluctuates greatly, causing investors to redeem their funds in fear of losing their returns or suffering further loss. If investors are constantly stressed about NAV volatility, it is difficult to commit to long-term investment.
Most investors of Minority’s first fund which was launched seven years ago are still with us today. We have together experienced the market downturn in 2013, the stock crash in 2015, the trading melting downs in 2016, Sino-US trade conflicts in 2018, and the COVID-19 pandemic in 2020. Our investors have built up trust in Minority over the years in such a dynamic market.
Investing in a volatile stock market is not an easy task. Three years away from our tenth anniversary, we are on track to achieve our goal of making NAV increase ten times in ten years. Rather than a performance promise, this is a target we strive to accomplish. To achieve this, we will need to have a compound annual return of 26% since inception.
The year of 2020 was not a best year for large blue-chips and has been a challenging year for our investors and ourselves. Due to the impact of COVID-19, there has been significant sector divergence in the market. While large blue-chips have made healthy annual return, they are way behind many popular sectors. Can we maintain high convictions in the strategy and keep objective judgement? Can investors withstand the market challenges and hold on to their investment?
The purpose of investments is to accumulate wealth in the long term rather than in one or two years. A good investment strategy can weather bull-bear market and style shifts, and make meaningful returns. Investors who have experienced the rise and bust of the 2015 China stock market will be able to understand this concept, yet the lessons from 2015 have begun to be forgotten by the market.
Looking ahead to the year 2021, we are confident that large blue-chips remain very attractive risk-return ratio and majority bias will be corrected. For example, the year 2020 is a turning point for Chinese banks’ profit growth, and we expect an acceleration in their net profit increase in the coming years.
Market fluctuations are hard to tell. However, the potential risks and gains of stocks can be estimated. Market prices have already reflected what has happened. But like the Sino-US trade conflicts and COVID-19 pandemic, impact from future events is unpredictable. Rather than trying to anticipate those unpredictable events, we will continue to focus on majority bias that has already exist.