If Yale were Socrates in the endowment approach world, MIT would be Plato.

In Philosophy 101, we learned: Socrates believed in being just, he states that everything has a role to play, and must play it well enough. He also believed that everything is characterized by a virtue that has a direct relationship with the performance of its function. While Plato, argues that injustice cannot be better than justice, he argues that each function is dependent on the community one finds himself. That is, a person’s function and his ability to carry it out effectively is highly dependent on the community in which one lives.

What is the function of emerging managers in the allocator’s portfolio? We think it depends on what kind of allocators you are. If you can identify young and talented managers at a very early stage of their professional career and you can take a long-term bet on their future growth, the emerging managers have a valid function in your portfolio. If you cannot make such a judgment and bet, the emerging managers are not a very good fit.

MIT recently launched a website titled “Emerging Managers” https://mitimco.org/emerging-managers/. You don’t need to read the rest of this email if you can click the link and go to MIT’s website. It’s worth reading.

I found no surprise in MIT’s thoughts, but am grateful that they published this to a wide audience so that the allocators’ community has an opportunity to think. Due to the high execution challenges, emerging managers are not for most allocators, but we should at least think about how we should face these challenges. I also compared MIT to Yale using the example of Socrates and MIT, but it doesn’t mean Yale doesn’t find “function” in emerging managers. It’s actually quite opposite as I know Yale actively invests in emerging managers. MIT refined the idea of emerging managers, which is not very different from Yale’s fundamental belief.

From the MIT website:

Very often we become skeptical if the fund size is too small. Why don’t they have more money from previous experiences? How can you say you can make money if you haven’t made enough money for yourself? Can they survive before they hit the breakeven point? However, we should also help young managers to build their equity by providing capital when anyone else wants. Everybody starts from somewhere like Steve Jobs started Apple at his garage.

We want to generate a higher return. Why don’t we take ownership to compensate? However, this decision will put me in a conflicted situation as we cannot help the manager to raise more capital to maximize the return, resulting in a lower return on capital. This special connection also makes it difficult to terminate a relationship when we have to.

Can we commit 10 years with a manager with nearly zero history? Isn’t it too much? However, a stable capital means peace of mind. No matter how smart they are, the managers are human beings and their performance is influenced by non-investment-related matters. Eliminating fear of losing business can improve their performance in a long run.

We are the early supporters and want to help the managers, so they should listen to us. However, we also need to trust our managers’ judgments on portfolio and business management. They definitely know a lot of things better than us and that’s why we invest. Why do we want to control them?

Here are MIT’s answers to my questions.

Emerging Manager Examples (from the website)

Here are some examples of firms we backed in the past few years:

• A one-person stockpicking firm based in San Francisco with $10 million of AUM (as you can see, we like small firms with long runways!)
• A private equity firm based in New York operating with an evergreen fund structure (as you can see, we like unconventional firms!
• A real estate firm in San Francisco transitioning from deal by deal capital to a discretionary fund structure (as you can see, we like finding firms early!)
• A one-person stockpicker, based in Mumbai, with a decade plus track record of compounding his own money, who now manages MIT’s money alongside his own
• A private growth equity firm based in London raising its first institutional fund

GS’s Peter Oppenheimer published a very interesting research paper on Mar 22, 2021. I recommend everybody should read this. The link for this paper is at the end of this article. Oppenheimer is trying to present why the current market cycle is not a bubble… more precisely speaking, not a typical bubble.

Typical characteristics of historical bubbles.

While I agree with these characteristics of bubbles and some of his arguments, I think he tried too hard to justify the current elevated valuation of the stock market. The first principle of a good investment is always “buy low, sell high.”

By the way, I found this chart interesting. Apple is now nearly 7% of S&P 500, the highest level we haven’t seen after GM fell from the rank.

Global Strategy Paper — Bubble Puzzle — A guide to bubbles and why were not in one

https://starmagnoliacapital.docsend.com/view/jzbtb5dhj6g9kyhp

It was 2006, a very early day of my career when Fir Tree’s founder, Jeff Tennenbaum, gave us a “lecture” on SPAC. It was still a nascent market with very limited participants and Fir Tree was one of them. Jeff eventually connected us with EarlyBirdCapital, the only investment bank specialized in SPAC. We had a series of educational conversations on SPAC.

Jeff Tennenbaum is now running Titan Grove — it’s an interesting company that owns many impact businesses. He was a pioneer of ESG (before it was called ESG), too.

https://www.titangrove.com/

After the 2008 market debacle, SPAC lost popularity (again) until we saw a recovery in 2020. During the year, US-listed SPACs represented 53% of all US IPOs, according to Nasdaq and SPAC Alpha. In 2021, 79% of all US IPOs were SPAC. If you think it’s not a bubble, I don’t know what it is.

SPAC was a good investment for everyone. If you invest in the bottom 15% of SPAC, you still made money between Jan 1, 2019, to Jan 22, 2021 (3%). However, you want to pay a lot closer attention to the performance of the Sponsor. The average return of SPAC for Sponsor is 958% and the return of the bottom 15% was 178%. When you consider investing in SPAC, you should know if you are the predator or the game.

On April 4, China observes Qingming Festival, a tomb-sweeping day, this year. Ahead of this memorial day, the Wuhan government decided to release ashes of virus victims from the city’s 7–8 crematoriums. Each crematory plans to distribute 500 per day, up to Qingming Festival. Some people are speculating that the total number of the death can top up to 5,000 over the next 10 days (500 per day * 10 days = 5,000), far exceeding the total number of reported deaths (2,538). Is the Wuhan government lying the total number of victims?

Generally speaking, I don’t blindly trust figures released by any government. They are just useful guidance, which could be manipulated quite easily by interested parties. The quality of the figures reported by Chinese governments is generally lower than other governments for sure and we need to think twice and thrice if the figures really make sense. For example, the Chinese government later confirmed that the “new infection case number” they release does not include asymptomatic cases, making it very difficult to compare against the figures reported by other countries.

I always ask myself which number I can trust… or least the risk of manipulation. Unfortunately, in the case of the current virus outbreak, it’s the total number of deaths, not only caused by the virus, but by all causes. This is the figure very difficult to manipulate because you cannot erase the memories of people (unless you kill everyone).

My team found data available released by the Wuhan government for the last two years ( http://mzj.wuhan.gov.cn/tjxx/387166.jhtml). During the period, Wuhan government has very little incentive to report false figures. According to this data, Wuhan had 56,007 cremations in 2019, which is 462 per day. The figures have been quite consistent and very close to China’s national-level mortality rate reported by the World Bank. I think the figures are reliable.

• Assuming the city has 8 crematoria, each crematorium has 58 cremations a day.
• Assuming each crematorium has 20 furnaces, each furnace burn 3 bodies a day before the outbreakost of the friends in Europe and the United States probably do not know, but based on my experiences, it takes a lot of time to burn the human body. It takes about 3–4 hours. That means each furnace is used 9–12 hours a day. Most crematories usually do not have much excess capacity because as the data below shows the number of death does not fluctuate very widely.

Most of the deaths caused by the virus occurred within a month period, meaning 11 additional cremations per crematorium per day, or just 20% more than the historical average. Many media reported that crematorium was running the furnaces almost 20 hours a day in February. That definitely raises a question if the additional deaths caused by the virus were actually higher, probably 5,000–7,500.

Wuhan’s death toll is translated into 5.0% mortality rate, which seems quite low compared to Italy’s 11.0% as of today. Wuhan was the epicenter and front line doctors did not know how to deal with the situations at the beginning. The medical supplies were critically in shortage as the city was locked down completely. There must be many victims who had died before properly diagnosed. Assuming Wuhan’s mortality rate is the same as Italy’s, the total death toll should be higher than 5,000, probably 6,000–7,000. Wuhan government is expected to release Q1 figures in May. At that time, we can confirm if this assumption was reasonable.

You may wonder… what is the point of doing this? As a long-term investor, it is important for us o know the worse case scenario so that we can understand the real degree of margin of safety when we make investment decisions. Understanding what happened in China over the last two months is very useful guidance for the rest of the world. For example, during the two months period, China lost 20 mm employment. China’s labor force is approximately 800–900 mm, so that’s about 2.5% of unemployment. Last week, 3.3 mm Americans filed for unemployment benefit, or 2% of the labor force. In case of the United States, the actual unemployment rate may increase more.

What people tend to forget is that the US economy has created almost 10 mm employment since 2016 and the actual unemployment rate was well below the Natural Rate of Unemployment, i.e. the economy created too many jobs. So, even though we lose 4 mm jobs, it will just bring us back to 2013 level. During the recession time, it’s natural to lose jobs. And, if we use China’s experiences as guidance, society will find a way to operate “remotely” and create more jobs.

Let’s not get fooled by the big numbers.

Originally published on June 27, 2016

“Like Michelangelo’s paintings and sculptures, successful businesses are the by-product of inspiration, hard work, and no small amount of genius. And like the works of the Great Masters, only a small minority stand the test of time and last over the long run.”

J.P. Morgan Asset Management’s “The Agony & Ecstasy — The Risks and Rewards of a Concentrated Stock Position” is a very interesting reading piece as it discusses some key topics that an investor should think when managing an equity portfolio. Named after Irving Stone’s famous biographical novel, JP Morgan conducted extensive analysis on S&P 500 and Russell 3000 constituents going back to 1980 and found that:

• Risk of permanent impairment. Using a universe of Russell 3000 companies since 1980, roughly 40% of all stocks have suffered a permanent 70%+ decline from their peak value. For Technology, Biotech and Metals & Mining, the numbers were considerably higher.
• Negative lifetime returns vs. the broad market. Two-thirds of all stocks underperformed vs the Russell 3000 Index, and 40% of the stocks’ absolute return were negative.
• Concentration vs Diversification. After incorporating the issue of single stock volatility, J.P. Morgan found that 75% of all concentrated stockholders would have benefitted from some amount of diversification.

We agree with the first two conclusions while we have a different view on the third. While diversification is an important tool to manage risks, excess diversification will also be harmful for long-term wealth creation. Our Endowment Approach suggests that we should diversify our portfolio by asset class and geography, but our managers should manage rather concentrated portfolios.

Catastrophic Loss

The study focuses on U.S. stocks that experienced “Catastrophic Loss”, which is defined as a stock that experienced a 70% of more decline from its peak and never recovered back to the 60% level from its peak. From 1980 to 2014, 40% of all stocks experienced such declines. For Information Technology companies, almost 2/3 of companies experienced the Catastrophic Loss! These loss rates tend to rise during recessions and market corrections, but J.P. Morgan argues, there is a steady pace of distress even during economic expansions.

Median Excess Return is Negative

J.P. Morgan also calculated how many Russell 3000 constituent companies actually outperformed the index and concluded 2/3 of the companies underperformed the index. Even more shockingly, 40% of the companies generated negative absolute returns. To our encouragement, there were some extreme winners which compensated losses of other companies, however, only 7% of the universe is qualified for that prestige.

Consumer Staples Shines

Among 10 sectors in the study, Consumer Staples stood out. The median excess return vs. Russell 3000 of Consumer Staples was only -3% while the average of all other sectors was -67%. The Consumer Staple companies that experienced the catastrophic loss were “often low-margin supermarket, drug store and convenience store chains that struggled to compete with the rise of Walmart. The list of the winners for the past 10 years include: Colgate-Palmolive Company, Hershey Company, Keurig Green Mountain Inc, Sysco Corporation, Tyson Foods and Wal-Mart Stores.

Diversification or Concentration?

The study concludes that, while concentration is an effective engine of wealth creation, it is extremely difficult to keep fortunes aloft through highly concentrated portfolio. We do not disagree with this conclusion as we believe diversification is an effective tool to control risk, but we also believe that too much diversification actually causes risks for long-term wealth creation. If you invest in an equal-weighted portfolio of Russell 3000 companies, you will most likely underperform the index. To generate good returns, you still need to invest with concentration.

Manager Selection

Generally speaking, we are sector agnostic, but we occasionally find excellent sector-focused public managers in Information Technology and Consumer Staples. Interestingly, both of Information Technology and Consumer Staples managers are fundamentally-driven stock pickers with a long investment time horizon even though their portfolio management approaches are different. Information Technology managers tend to have more balanced long and short approach with relatively low net exposure whereas Consumer Staples managers tend to be more long-bias and long-only or long-bias. We selected these managers based on our experiences and instinct, but J.P. Morgan’s study confirmed that our manager selection was supported by the empirical evidence.

Hedge funds are criticized for the poor performance over the last few years partly due to the high level of concentration. In our view, those who experienced recent Catastrophic Losses of their portfolio companies (e.g. Valeant, Sun Edison) were caused by the toxic combination of concentration and herd mentality. However, we should not dismiss the importance of concentration by these bad examples. Concentration does have benefit for active portfolio management as managers can allocate their limited resources to the best ideas. By investing equal-weighted diversified portfolio, you may be able to avoid landmines, but you will most likely end up with significant underperformance to market cap weighted index (i.e. larger allocation to larger companies), such as S&P 500 and Russell 3000. For our endowment approach, this is a significant risk that we cannot overlook.

Originally published on 7 August 2017

“Nothing to Do with Value”

The May 5, 2017 edition of Grant’s Interest Observer featured an interview with Mr. Frank Brosens, co-founder of Taconic Capital. Brosens, who succeeded Goldman Sachs’ risk arbitrage department after Bob Rubin became U.S. Treasury Secretary for President Clinton, and a master of risk, all sorts of risks. He expresses his concerns over the investors’ behavior who ignore value.

“Nothing to do with value”? The phrase rings a bell. Only begin to consider the $21 trillion or so of today’s invested capital that belongs to value-indifferent stewards. The central bankers couldn’t care less about price or value; they buy bonds (the Swiss and the Japanese also buy stocks or ETFs) to promote growth or inflation or some other macroeconomic variable, not to make money, though — to be sure — they do “make money.” They print it.

Public investors in index funds are no more attuned to value than the central bankers are. As indexed investors, in fact, they must be value-avoidant, or at least, value-agnostic, as index funds mechanically buy stocks according to the size of their market capitalization. Size trumps value.

And what do the buyers of exchange traded funds care about ratios of price to earnings or operating income to fixed charges? Most buy ETFs to “gain exposure” to a certain asset class, industry or investment concept. You can’t pretend to pick stocks or bonds when the ETF you buy owns dozens of them.

Value-agnostic is probably a new buzzword to be successful in today’s investment world. This investor “preference” clearly pushed the valuation to the level we have seen twice in the last 130 years… the Black Tuesday in 1929 and the first Internet Bubble in 2000, measured by Case Shiller P/E Ratio. (Exhibit 1)

So, what really is the passive investing? Howard Marks’ recent letter, There They Go Again… Again, describes a brief history (50 years) of passive investments in an excellent way.

Fifty years ago, shortly after arriving at the University of Chicago for graduate school, I was taught that thanks to market efficiency, (a) assets are priced to provide fair risk-adjusted returns and (b) no one can consistently find the exceptions. In other words, “you can’t beat the market.” Our professors even advanced the idea of buying a little bit of each stock as a can’t-fail, low-cost way to outperform the stock pickers.

John Boggle put that suggestion into practice. Having founded Vanguard a year earlier, he launched the First Index Investment Trust in 1975, the first index fund to reach commercial scale. As a vehicle designed to emulate the S&P 500, it was later renamed the Vanguard 500 Index Fund.

The concept of indexation, or passive investing, grew gradually over the next four decades, until it accounted for 20% of equity mutual fund assets in 2014. Given the generally lagging performance of active managers over the last dozen or so years, as well as the creation of ETFs, or exchange-traded funds, which make transacting simpler, the shift from active to passive investing has accelerated. Today it’s powerful movement that has expanded to over 37% of equity fund assets. In the last ten years, $1.4 trillion has flowed into index mutual funds and ETFs (and $1.2 trillion out of actively managed mutual funds).

J.P. Morgan publishes annual Global ETF Handbook, which estimates total ETF assets under management reached $4.0 tn globally (Exhibit 3) and the number of listed ETFs globally has grown to more than 7,000. In the United States alone, there are more than 2,000 ETFs. J.P. Morgan also estimates the number of listed companies in the United States is roughly 4,000, down 46% from its peak of 8,025 in 1996.

The size of the US ETF market stands at $1.7 tn in domestic equity funds (equivalent to 6.4% of the total US equity market cap of $26.7 tn). J.P. Morgan says “as ETFs became an increasingly important part of US markets, investors started using ETFs as a hedging and positioning tool. In recent years ETF trading volume represented ~25–30% of the total average US equity trading volume (Exhibit 4), meaning investors trade ETFs 6x more frequently than individual stocks. During the 2008–2009 financial crisis, ETF represented almost 50% of the total average US equity trading volume and, not surprisingly, the ratio of ETF to total trading volume has a significantly high correlation to VIX, which measures expected volatility of the stock markets.

So, why is Brosens, the master of all sorts of risks, worried so much about passive investments, which believed to reduce, not increase, costs of your portfolio? The reason — we became too passive, or passive-aggressive.

Like Brosens, Marks also expresses his concerns and negative impacts of the excessive popularity of the passive investing:

Remember, the wisdom of passive investing stems from the belief that the efforts of active investors cause assets to be fairly priced — that’s why there are no bargains to find. But what happens when the majority of equity investment comes to be managed passively? Then prices will be freer to diverge from “fair,” and bargains (and over-pricings) should become more commonplace.

Even Bogle, the father of passive investing, recognizes the problem. At this year’s annual shareholders meeting of Berkshire Hathaway in Omaha, he said:

“If everybody index, the only word you could use is chaos, catastrophe.”

“There would be no trading, there would be no way to convert a stream of income into a pile of capital or a pile of capital into a stream of income. The markets would fail.”

And, if investors become excessively passive, or passive-aggressive, the valuation of the equity markets will be distorted or skewed. To explain this, Marks quotes a brilliant comment from Barron’s:

With cap-weighted indexes, index buyers have no discretion but to load up on stocks that are already overweight (and often pricey) and neglect those already underweight. That’s the opposite of buy low, sell high.

Marc Faber, our favorite macroeconomics commentator, gives a similar observation in his May 2017 edition of The Gloom, Boom & Doom Report, A More Promising Future for Active Managers. (we highly recommend everybody subscribe Faber’s newsletter. For $800, you will receive 12 newsletters full of deep insights and investment ideas!)

By definition, an index fund will always have its largest exposure to the highest market capitalization stocks, which are in most cases the most expensive ones as well. Think of Japan in 1989 when its stock market capitalization made up 50% of global stock market cap. A global equity index fund would have had 50% of its holdings in ludicrously overpriced Japanese equities, whereas any responsible active manager (a money manager who remembers that fund management entails a fiduciary duty) would by 1989 have been significantly underweighted Japanese equities.

When you look at the stock performance difference between The Big 5 (Apple, Microsoft, Amazon, Google and Facebook) vs. S&P 495 (S&P 495 is an index of 495 or so companies included in S&P 500 except for the Big 5) as well as the concentration of NASDAQ 100 in the largest five stocks.

Some of you might remember our article titled Thoughts on Catastrophic Losses and Hidden Risk of Diversification. We discussed that J.P. Morgan Asset Management found that, from 1980 to 2014, 40% of all stocks in the United States experienced “Catastrophic Loss”, which is defined as a stock that experienced a 70% of more decline from its peak and never recovered back to the 60% level from its peak. And, importantly, for Information Technology companies, almost 2/3 of companies experienced the Catastrophic Loss.

Days of Being Passive-Aggressive

“It is passive-aggressive behavior, the donning of a mask of amiability that conceals raw antagonism toward one’s competitors, even one’s friends.”

— Hilary De Vries, New York Times

Yuddy: I’ve heard that there’s a kind of bird without legs that can only fly and fly, and sleep in the wind when it is tired. The bird only lands once in its life… that’s when it dies.

Yuddy: Hey, have you heard of a kind of bird…

Tide: [interrupting] The kind without legs, right? This kind of nonsense can only fool the girls!

— From Days of Being Wild

Passive investing is like Yuddy’s bird story (in this case, he is referring to himself). Its gloomy fate attract sympathy from equally gloomy girls like a quiet lass named Su Li-zhen, who works at a sports arena, and glitzy showgirl named Mimi. Perhaps due to his unresolved Oedipal issues, he passively lets the two compete for him, unable or unwilling to make a choice. Eventually, Yoddy lost both girls.

We are not a Yuddy’s bird. We have legs and know when to fly, how to land. We know when to buy, how to sell. However, for active investment managers who believe in fundamental-driven, long-term and concentrated investment approach, making life during the Days of Being Passive-Aggressive hasn’t been easy.

In the same May 2017 letter, Faber also shares his experiences with Overlook Partners Fund in Hong Kong, which was founded by Richard Lawrence in 1992 (note: we have no investment in Overlook). Outlook has one of the best long-term performance records in Asia (and potentially in the world) by delivering 13.9% of returns over the last 25 years, which includes the Asian Currency Crisis in 1997–1998, the first Internet Bubble in 2000 and the Financial Crisis of 2008. Overlook’s business is based upon the following principles:

• One fund and one co-investment fund
• One asset class
• One investment philosophy
• Focused portfolio with 20–22 holdings
• A small team incentivized by long-term compensation

As the world is dominated by the passive and valuation-agnostic investors, in the long-run, there will be more and more opportunities for the long-term value-focus investors like Overlook. The long-term focus means we do not, and are not supposed to, make money all the time. When the equity markets will eventually collapse, there will be many big babies thrown out with bathwater. We just don’t know if it is happening tomorrow or three years from now.

Days of Being Wild is a 1990 Hong Kong drama film directed by Wong Kar-wai. The movie is set in Hong Kong and the Philippines in 1960–61. Yuddy, or “York” in English (Leslie Cheung), is a playboy in Hong Kong and is well known for stealing girls’ hearts and breaking them. Yuddy learns from the drunken ex-prostitute who raised him that she is not his real mother. Hoping to hold onto him, she refuses to divulge the name of his real birth mother. The revelation shakes Yuddy to his very core, unleashing a cascade of conflicting emotions. His first lover in the film is Li-zhen (Maggie Cheung), who suffers emotional and mental depression as a result of Yuddy’s wayward attitude. Li-zhen eventually seeks much-needed solace from a sympathetic policeman named Tide (Andy Lau). Yuddy’s next romance is with a vicious cabaret dancer whose stage name is Mimi (Carina Lau). Unsurprisingly, Yuddy dumps her too and she begins a period of self-destruction. Yuddy initiates romantic relationships but refuses to commit to the relationship and is unwilling to make compromises.

Yale Investment Office published the endowment’s 2019 performance (between July 2018 to June 2019). During the period, the endowment asset value rose 5.7%, bringing the total size to $30.3 bn. Some critics said the endowment model is not working as it underperformed S&P 500 significantly during the period and praised index fund investments. For example, Bill Abt, former CIO of Carthage College in Wisconsin, which manages about $123 mm, said Ivy League endowments “totally misplayed the market. They’re underperforming and their expenses are extra high with alternative investments.” Other critics argue that the US stocks are the best performer and will continue performing better than other markets. Although we focus on generating absolute returns, we need some “guidance” to measure our managers’ performance and often use S&P 500. Unfortunately, 99% of the managers, regardless they are long/short equity or long-only, underperform S&P 500.

Index Investment Makes Sense Only For Patient Investors

Actually, when I meet with a wealthy family with a relatively small asset base, I highly encourage them to follow the index investing. Instead of listening to private bankers’ smooth pitch and following their investment advice, which only enrich the bank and banker, not clients, it makes a total sense to create a portfolio using Vanguard funds and leave the portfolio for 3–5 years (with minor allocation adjustments). Unfortunately, many investors want to trade index funds and their trading habits add very little value, if not damage. Another problem is the index investing is quite boring and too stable. Many allocators want to add value by doing something and they often come up with a long solution like “Smart Beta”. The beauty of index investing is to remove your irrational judgment so that your portfolio is broadly diversified. Having said that, we also know that more than 1% of the managers we meet consistently generate superior returns (although they may not outperform S&P 500) and we should stick with these managers. We have to pay high fees, but we can still generate better returns and we can also detach our emotional value destruction asset rotation from us. People generate returns after all.

Assets in Passive Funds Exceeded Active Funds For the First Time

Standard & Poor’s or Swine & Pork’s

Princeton’s Andrew Golden, protégé of David Swensen, admitted that the international markets were not a great to be. It is true that S&P 500 outperformed and retrospectively it was stupid to invest in non-US markets for sure (I’m talking about public markets in general, but it is probably the same for private markets, even including China).

Let me give you an example: due to the swine flu in China, the global hog price went up a lot over the last 12 months. In China, the wholesale price rose more than 100%, making Shanghai’s housewives worried about tomorrow’s dinner menu. If someone said, “pork was the best performer in the world over the last 12 months, so you should buy now,” would you follow his recommendation? I’m sure you won’t and the same goes to S&P 500. Golden said, “We don’t buy into the idea that U.S. stock market is the best benchmark or even the best context for what we do. That will prove to be wise when the stock market stops going from low valuations to extremely high valuations.”

As shown in the charts below, there are many pieces of evidence of relative expensiveness of US equity markets.

Yale vs. Berkshire

Over the last 20 years, which include two recessions, Yale managed to generate 11.4% annualized return. Even over the last three years, its 9.7% p.a. return outperformed Berkshire Hathaway with more than 3.0% p.a. although Yale’s performance was dragged by its international and absolute return exposures. I think Berkshire Hathaway is an interesting “benchmark” if you consider Warren Buffett as one of the best asset managers in the world’s history. If you invest in Berkshire Hathaway, you don’t have to pay the hefty performance fee since Buffett is not interested in drawing salary to maintain his modest life style (but, you are subject to pay tax, unfortunately).

More Ventures, More Buyout, Less Absolute Return

Yale only reports its target, instead of actual, allocation until its annual report is published later next year, however, we can analyze how Yale is thinking about its allocation decision. While it’s important to know the level of their allocation to each asset class, it is more meaningful to follow its trends. This year, we were able to identify three important trends.

Firstly, Yale started reducing its allocation to Absolute Return for the first time in the last 10 years. Unlike other endowments, Yale consistently increased target allocation to Absolute Return, making Absolute Return the largest asset class. This trend changed.

Secondly, Yale increased allocation to both Venture Capital and Leveraged Buyout (Yale does not have “Growth Equity” as an asset class). Yale’s asset allocation to Venture Capital consistently increased since 2005 without any up or down. The target allocation to Venture Capital is now 21.5%, tad below Absolute Return’s 23.0%. The increase was partially due to the appreciation of the underlying assets, but I believe Yale is adding capital to Venture Capital, instead of reducing.

Thirdly, Yale began increasing its allocation to Leveraged Buyout, reversing its earlier trend. The target allocation to Leverage Buyout peaked in 2015. Importantly, Leveraged Buyout is the asset class Yale added very little excess return over the last 10 years (although it was better than Real Estate). To me, it was a surprise as the investment environment in Leveraged Buyout is worsening as the availability of cheap debt keeps pushing the valuation multiple high.

I will report more when Yale publishes its annual report.

Shinya

Last year we launched Generation Z Investment Club (“Z Club”) with 22 students. We had a lot of fun and learned a lot together. We organized an online investment education session, ran several investment case studies, managed their own portfolios, wrote newsletters and met with incredibly talented and experienced investment managers, who shared with us their life lessons. Despite challenges for our members locating in 4 different cities (Beijing, Shanghai, Hangzhou and Singapore), our members enjoyed both online and offline interactions and collaborations. We also invited Team Icho, which won the first Z Cup, to the Invest Your Life Trip in Hong Kong where they had opportunities to meet great investors.

This year we decided to be more adventurous by inviting 21 new members from 7 different cities (Beijing, Shanghai, Hangzhou, Shenzhen, Singapore, London and New York). With two members promoted as mentors and one member withdrawn, Z Club today now consists of 40-strong members from six different countries (China, Malaysia, Singapore, Morocco, Lebanon and Myanmar). We don’t discriminate students by their academic background, but all students are from prestigious universities around the world.

We are truly thrilled by the new and existing members. They will be the next generation investors and thought leaders. Thank you very much for your continuous interests and supports on Z Club. We look forward to delivering more and more exciting news of our activities!

“The most exciting thing about joining Z Club is the opportunity to manage my own portfolio. This is an ideal community to appreciate value investing.”

KONG Soon Lee, Nanyang Technology University, Singapore, Team Spring

“I’m looking forward to expanding my network through Z Club and meeting more like-minded peers!”

Jared Lim, National University of Singapore, Singapore, Team Spring

“I don’t have any investment experience, but I can’t wait to learn with my friends and start my own investment!“

Silver Huang, Sun Yat-sen University, Guangzhou, Team Veritas

“I very much agree with Z Club’s motto: Invest Your Life. I look forward to learning about investment together!”

Frank Huang, Shanghai Advanced Institute of Finance (Shanghai Jiaotong University), Shanghai, Team Philosophy

“In the past, my investment was more macro-based and less fundamental-based; I look forward to learning more about fundamental investments at Z Club.”

Rocky Lu, Tsinghua University, Beijing, Team GenBridge

“My previous internship experience is debt-investment related, so I know very little about equity. I want to improve my analytical skills at Z Club.”

June Tan, Nanyang Technology University, Singapore, Team Spring

“I’m very interested in the logic of investment and that was the reason I joined Z Club. I want to gain more professional perspectives.”

WONG Zhi Hang, National University of Singapore, Singapore, Team Spring

“I have experiences in investing in Hong Kong stocks, but it is not enough. I want to gain more knowledge with Z Club.”

Lynn Bo, Beijing, Team Femme Fatale

“In terms of my future career development, I’m very interested in equity investment and I always hope to create social value. Investing is one of the most important ways to create value for the society.”

Janus Zhang, Tsinghua University, Beijing, Team Veritas

“I am looking forward to learning systematic knowledge about stock valuation and how to apply it in real life!”

Gerald Chia, National University of Singapore, Singapore, Team Arisaig

“Being able to communicate with industry experts is one of the most attractive reasons to join Z Club!”

Sichong Cao, Tsinghua University, Beijing, Team GenBridge

“I hope to communicate with like-minded friends and industry experts through Z Club.”

Carol He, Fudan University, Shanghai, Team Philosophy

“I’ve been looking forward to meeting more partners who have the same passion for investment!”

See Mun Chan, Zhejiang University, Hangzhou, Team Spring

“I used to feel ‘lonely’ about investing because I have nobody to talk about it. Now, I am very happy to join this family. I hope I can find a breakthrough and gain new knowledge with Z Club!”

Jason Xiao, Imperial College London, London, Team Femme Fatale

“Hope to learn more about value investing!”

Clover Wang, Tsinghua University, Beijing, Team Star Magnolia

“In addition to gaining more knowledge, I’m very excited about the opportunity to manage our own portfolio!”

LIM Zheng Xiang, National University of Singapore, Singapore, Team Arisaig

“The systematic courses and portfolio management experience provided by Z Club are very exciting.”

Yuke Li, Peking University, Beijing, Team Philosophy

“I have some experiences in A-share market, but I wish to expand my scope!”

Elsa Xu, Zhejiang University, Hangzhou, Team Icho

“I want to learn more about investing!”

Alaedine Belhouari, Columbia University, New York, Team Atlas

“I am going to make the first investment in my life!”

Mossen Dalloul, Columbia University, New York, Team Atlas

“Z Club is very diversified. I’m looking forward to communicating with new friends of different backgrounds and countries!”

Saad Sebti, Columbia University, New York, Team Atlas

Dear Friends,

We are pleased to share with you the second monthly newsletters for the portfolios managed by the Generation Z Investment Club (“Z Club”).

Please note that Z Club’s Endowment Program is not open for external capital and managed solely for an educational and experience purpose.

Please click the link below to read the latest monthly newsletters, written by our members. The Chinese version is also available on our Wechat Public Account. Please share your feedback with us for our members’ benefits. Constructive criticism is always welcome. We are also happy to connect you with any team members if you find their newsletters interesting.

Team Veritas’s Veritas Aequitas Fund link

• Up 2.1% in Aug; up 2.2% YTD
• Further discussion on the Investment Thesis
• Update on Alibaba (40% of NAV)

Team GenBridge’s A Fund link

• Down 2.0% in Aug; down 2.3% YTD
• Invest in businesses that “any idiot can run”
• Discussion on new positions: Baidu and Tiali Education

Team Icho’s Goat Fund link

• Up 0.9% in Aug; Up 1.1% YTD
• Discussion on Juewei

Team Star Magnolia’s Techplus Fund link

• Up 0.2% in Aug; Up 0.2% YTD
• Discussion on US-China Trade War
• Update on ZTO
• Discussion on Meituan-Dianping

Team Femme Fatale’s Femme Fatale Fund link

• Down 13.9% in Aug; Down 17.2% YTD
• Discussion on PVH’s recent earnings

Team Arisaig’s Viva Fund link

• Up 0.7% in Aug; up 0.9% YTD
• Discussion on new idea: Kellogg
• Update on AT&T

As you know, Z Club is a non-profit organization established in 2018 with the aim of helping our next generation to start their journey of becoming investors with a long-term mindset. As a part of our program, we provided initial $5,000 capital to be managed by 6 teams (the “Endowment Program”). Each team is comprised of 3–4 university students in China and Singapore. They manage highly concentrated portfolios of public equity positions based on their fundamental research. The investment process is designed to be collaborative and structured as each investment must be discussed and agreed at an investment committee.

We welcome your feedback and suggestions. If you know someone who is interested in offering internship opportunities for students who are gaining real-money investment experiences based on their own judgment, please let us know.

Follow us on Wechat!

Dear Friends,

We are pleased to share with you the monthly newsletters for the portfolios managed by the Generation Z Investment Club (“Z Club”). As you know, Z Club is a non-profit organization established by my partner Tiffany Liu (Vice President) and me in 2018 with the aim of helping our next generation to start their journey of becoming investors with a long-term mindset. As a part of our program, we provided an initial $5,000 capital to be managed by 6 teams (the “Endowment Program”). Each team is comprised of 3–4 university students in China and Singapore. They manage highly concentrated portfolios of public equity positions based on their fundamental research. The investment process is designed to be collaborative and structured as each investment must be discussed and agreed at an investment committee.

In July, we organized our second Invest Your Life Journey in Hong Kong and 8 students participated in life-changing meetings with investors, all of whom are highly regarded in the industry, including Chartwell’s Mr. Ronald Chan, Overlook’s Ms. Lenonie Foong, and Mr. James Squire, Library’s Bill Zhu and Xu Liu, and Old Peak’s John Zwaanstra. They shared their life-long journey as investors. Thank you very much for sharing your precious time with us.

Please note that Z Club’s Endowment Program is not open for external capital and managed solely for an educational and experience purpose.

Please click the link below to read July 2019 monthly newsletters, written by our members (university students). The Chinese version is also available on our Wechat Public Account. Please share your feedback with us for our members’ benefits. Constructive criticism is always welcome. We are also happy to connect you with any team members if you find their newsletters interesting.

Team Arisaig’s Viva Fund - link

Team Veritas’s Veritas Aequitas Fund - link

Team GenBridge’s A Fund - link

Team Icho’s Goat Fund - link

Team Star Magnolia’s Techplus Fund - link

Team Femme Fatale’s Femme Fatale Fund - link

Previous Z Club Publications

An Investor Is Born

Zeroing-In on Generation Z

The Class of 2019

Project Z: Interview with Shinya Deguchi