Minority AM Liam Zhou: Integrating Different Investment Perspectives

Minority Asset Management   2021-11-03 本文章132阅读

Investment is a continuous learning and evolving journey. Market keeps changing and all the market participants keep evolving. There is no guarantee that the same method can always beat the market. What worked in the past may or may not work in the future. Evolving along with market is the only way to ensure long-term alpha.

We have been exploring Behavioral Finance Theory based investment methodology in China stock market for years. The inaugural “Minority Behavioral Finance Investment Essay Award” this year is our latest effort to promote applications of behavioral finance theory in Chinese stock market. Via proprietary research as well as extensive exchanges with industrial experts, we made some new breakthrough in terms of investment philosophy and methodology.

“Alpha comes from the majority’s bias” is our investment philosophy stemmed from behavioral finance theory. The share prices reflecting the majority’s expectations, and the bias of majority is the source of mispricing, which yields opportunities for us. Many investors are already familiar with this philosophy.

This philosophy actually contains two investment perspectives.

The first perspective is to invest in stocks that are not favored by the majority but the actual fundamentals are not as bad as expected. This is why we have been investing Chinese Banks, Property Developers and Insurers since 2016.

The second perspective is to invest in stocks that are already favored by the majority but actual fundamentals are even better than expected. We did invest along this perspective before 2015, but have not found many chances in recent years. These popular stocks generally have high valuations reflecting high market expectations. The challenge lies in what method one can use to determine that the actual fundamental is even better than the already high market expectations.

We produced a few new investment methods to apply the second perspective. In addition to our investment process and analytical framework, we also found more effective ways to analyze and evaluate the majority’s expectations. The stocks identified by this second perspective generally are popular among the majority, having high market expectations, mid-small cap, growth style and strong price momentum and investment horizon is relatively short.

The traits of second perspective complement the stocks selected from first perspective, which are generally unpopular among the majority, having low market expectations, large cap, value oriented, weak price momentum, and require longer investment horizon.

Integration of the two perspectives is necessary. Portfolio managers are usually good at one particular style or perspective. It is not easy to integrate two investment perspectives with very different characters. We aware the importance of such skill after years of weathering different market conditions and cycles. Our understanding of investment in China market is further improved after more research on behavioral finance theory and reflections on contrarian investment in the past two years, and we are now more adaptive for different investment perspectives.

Most improvements and breakthroughs do not happen in good times, but are achieved under challenging circumstances. Every portfolio manager will face his or her days of underperformance. Over the past 8 years, our strategy has experienced five rounds of drawdown or underperforming cycles. When the market is in favor, it is natural to think that one’s philosophy, strategy and judgement is flawless, which makes it difficult to reflect deeply and further improve. However, when the market is against the portfolio manager’s decision, it allows one to rid the overconfidence and provides an opportunity to reflect and improve. We are always grateful for the drills and the reflections brought by adversity and pressure.

For the stocks and sectors selected based on the first perspective, we will continue to hold. Chinese banks are trading near lowest valuation in history while having the best asset quality in a decade. The 2021Q3 results confirmed profit growth sustainability for major banks. While Chinese property developers might continue to facing monthly sales figures decline, the marginal loosening of credit policy will relieve liquidity pressure and recover market confidence. Leading property developers with healthy balance sheet will benefit in future land auctions and industry consolidation. The valuation of Chinese insurers has fully reflected the market’s pessimistic view on new business growth.

Meanwhile, we need to balance the portfolio style as well as short and long-term performance. We will add stocks selected on the second perspective over the next few months. We will continue to focus on the opportunities created by majority’s bias. The actual allocation and pace will depend on the market condition.

Overall, our strategy will be more balanced in terms of market cap and style. The sector exposure will be more diversified with more mid-small growth stocks included. The mid-small caps have shown strong momentum since 2021Q2. The overall PE ratio of Chinese mid-small caps is still at relatively low level according to historical data, and taking future growth into consideration, the PEG ratio is even lower. China equity mutual fund allocation of mid-small caps is at relatively low level with a sign of increase observed in 2021Q3.

The investment strategy adjustment is backed by our recent years’ research and adapting to the current market condition. While the stocks traits of the two investment perspectives are different, the overarching investment philosophy is still united under “alpha comes from the majority’s bias”. This integration allows us to capture more investment opportunities with more flexibilities, and improves strategy competence.

We believe this investment methodology evolution can cope with the changing environment, and confidently look forward to the test ahead.