A Hong Kong investor once told me that he considered Asia’s capital markets to be like breaking waves; their rhythms often violent, but ultimately, they make a steady progression up the shore. It has often been noted that many Asia investors play these short-term rhythms. But ultimately the tide does come in and there is room for the long-term investor. In my latest trip to Hong Kong, I was reminded of how people’s attitudes to investments there seem to differ from our own here at Matthews Asia. Not for the first time, I found myself having to filter a lot of the views I heard about companies and the markets. But I think I got a better understanding of how the stereotypical local equity investors' view might happily coexist with our own. The biggest difference between us is the time horizons that we use. The typical local investor uses a quarter-to-quarter timeframe, whereas we think in multiple years or a decade. Rather than saying who is right and who is wrong, if we accept these differences in time horizon, then much of the differences in method and philosophy can be explained too.
For example, one phrase I heard more than once was: "You can't be too demanding about corporate governance, because then you might miss out on the stock that is going to double in value." Well, this may be perfectly rational if you are planning to hold the stock for only a short period of time. After all, if someone is of a mind to misappropriate funds, it stands to reason that they have less of a chance of taking your money if you are not around for very long. The risk-reward of the short-term investor may still be favorable in a risky, poorly managed company in a cyclical upswing. But this approach is anathema to those who take a strategic view. After all, many years of accumulated profits can be lost in the blink of an eye due to bad governance or fraud. When I chatted about this with a colleague, he mused that it is: “like riding a tiger by the tail.” Quite true. And it means you probably spend all your time thinking about how you are going to dismount rather than enjoying the ride!
Another person in Hong Kong lamented that those in Asia with the highest appetite for risk seemed to experience the biggest shortfall of actual returns earned versus expected returns. This may merely be a case of excessive optimism. However, I have always believed there is an excess return to patience in Asia. Those investing in the riskiest assets, either from a point of view of volatility or balance sheet risk, may enjoy terrifically strong rallies from time to time that leave the rest of us standing in their dust. Nevertheless, over longer periods of time, in my opinion it has not paid to hold these risky stocks. Their historical returns, on average, over long periods, have been lower than those on less volatile, less distressed companies. Thus, such investors need to successfully time the cycles in sectors and markets: to get in, but just as quickly get out. To these traders, higher quality, slower-growing businesses, with less volatile stock prices are regarded as "defensive." And they may well be in the short term but data suggests that many historically have shown stronger performance over longer periods of time.
Dividends, too, are an area of differing views. Again, in Asia dividend-paying stocks have been thought of as defensive. Sure, such companies may have accumulated returns over time through a mixture of retained earnings and reinvested dividends, but in the short-run, they may be seen as slow-growing, as they do not reinvest all their capital. But, from a long-term perspective, it is not high reinvestment rates that generate sustainable growth; it is reinvestment at high marginal rates of return that allows companies to prosper. This demands too much patience for those looking to profit quickly from immediate changes in market sentiment about a company’s future prospects; therefore it can attract an excess return for the patient investor.
Ultimately, the long and the short-term have a symbiotic relationship. The risk-loving investor's focus on risk and sentiment may allow the patient investor to prosper over the long term while leaving short-term tactical money on the table for those nimble or lucky enough to find it. By the end of this trip, I felt I had a much deeper understanding of this relationship and I returned to San Francisco more than ever committed to our patient view.
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