Our lack of understanding in how different countries are being governed are rooted in bias, largely based on what we are familiar with and what we are not.
Earlier this year in Singapore, I was having a conversation with someone from a bank about the creditworthiness of large state-owned-entities in China. Surprisingly, he actually saw this as a “high risk” business. If the counter-party had been one of the more familiar titans of the finance industry, that sentiment would have been very different.
Apparently many still think that the business environment in China is still rampant with corruption and fraud. These same risks that investors are concerned about exist in many other countries as well, including the developed ones. Just take a look at 1MDB, Wirecard and Theranos.
I recall a company sergeant major during my national service days who once said,
“Soldiers all around the world behave in the same way once they put on their helmets and the uniform.”
It’s surprisingly true. The helmet is one equipment that reminds everyone that: at the very core, we are all the same. In a similar fashion, a blue-collared production line worker sitting in China, Philippines, Italy, the US or anywhere else in the world operates, say a machine, in more or less the same way. Because he is human, he experiences both good days and bad days. And on bad days, the quality of his work might be sub-standard. But at the end of every work day, he tries to get off punctually, goes back to his family, and starts his routine again the next day. You might attribute any quality defects to the fact that the product was manufactured in a relatively low cost location i.e. if something is lousy, it is easy to dismiss that it is cheap and “made in XXX”. After all we have been conditioned to conveniently draw trivial correlations between price and quality. Without this bias otherwise, you could have just as easily blamed it on the merchant who sold you the product.
But corruption, fraud and quality control are smaller problems in the bigger context of things these days---Earlier this year, JPMorgan allegedly issued an “un-investable” call on China equities as a reflection of its unpredictability and geopolitical risks.
All businesses need to embrace policy. Companies that end up on the wrong side of propaganda run the risk of getting cancelled, as can be seen from H&M’s business in China.
But being cancelled goes against our ideologies and learnings of the free market, which is: identifying an environment with favourable supply-demand dynamics and taking scientifically calculated risks in raising capital to make money. State intervention is non-existent.
For most places in the world, the market economy is the truth. In China, the authority is the truth. There’s no right or wrong. Most of us have simply been brought up imbued with the ideologies of an open economy that we become averse to a scenario in which autocratic intervention could make or break a business.
We fear what we do not know or what we cannot control. And because of this, many companies write this off or cast a huge premium on country risk.
Think for a moment how different the risk models and perceptions towards raising money (such as the weighted average cost of capital) would be for a domestic investor or owner of a Chinese company vs a foreign company. The assumptions driving the decision to invest should ideally be localized and go beyond the scientific calculations that we have been taught. Instead we consistently fall back on conventional wisdom (which are mostly capitalist-centered) defining what constitutes a 'mature' or 'stable' market return.
For example, a common risk management strategy in the West involves diversification i.e. as long as we have enough eggs in the basket, we can always afford a few bad ones. In China, risk management is less of a game involving statistics but more about developing, embracing the ecosystem, staying in alignment with policies, and in the process, minimising (or sometimes even zero-rizing) the incidence of 'bad eggs'. This is inherently a very different way of doing business and ultimately a very different perspective of risk. In a slightly similar parallel, while modern Western medicine adopts a targeted approach towards treating afflictions and eliminating the ‘bad parts’, Chinese medicine tends to be more holistic, treating the entire system, including the patterns of symptoms.
Because the fundamental perceptions and understanding of risks are different, many investors struggle with using scientific methods to quantify returns.
"Investment is a risky business, and China as a market, is not for the faint-hearted."
On closer look, most of the policies are probably not meant to be autocratic or unreasonable. They exist to maintain a certain social stability, encourage economic activity and safeguard certain national interests - as with any sovereign state.
Of course the whole inner workings of global trade are made up of many complex moving parts. But at the end of the day, these are just the rules of the game, and risk is just a measure of how well you think you can play that game.
Starting a business in the US almost seems like fortune favours the bold. In China it probably feels more like: You better do as you are told.
A very different image of entrepreneurship and doing business is portrayed in the West. Many of these are frequently sensationalised with stories of school dropouts creating billion dollar businesses, founders working out of a garage, cavalier businessmen who buck the trend, sidelining authority to grab resources on a level playing field, and numerous books celebrating corporate bravery.
My first-hand experience in understanding this difference was about 18 years ago when I embarked on the NUS Overseas College program in Shanghai. The idea of the program then was to replicate in China, the “success stories” of entrepreneurship in the US - championing research & innovation and commercialising it. China at that point of time was less interested in leading the charge on technology and chose to prioritise large scale infrastructure investment and market reforms around reining in foreign investment. Some of the best businesses at that time weren’t centred around tech but the seemingly more boring and less sexy sectors. It was a very different economy and no one in the cohort had the slightest clue of how to adapt the program objectives to such a market. We were all learning along the way (摸着石头过河) from attending business meetings, fraternizing with colleagues, all the way down to getting visas and negotiating the rent on the apartment.
We would later on also learn that the strategy of navigating in China (which probably still applies today), wasn’t so much about being the smartest guy in the room but more about handshakes and being able to connect the dots.
Ideas and intelligence are nothing without endorsement.
As such, individuals and high achievers who are used to thriving in a merit-based world and expect to use their minds to blow everyone off their seats will often find themselves stumbling in such an environment.
Also, all the most important decisions are made centrally. There is almost always either a single decision maker or a small trusted circle of influence (almost mirroring the CCP style of governing) or if you like, using different share classes in a more western centric context.
Language is culture and culture is language. Being effectively bilingual might be sufficient, but being able to speak the language does not automatically imply that you can assimilate into the culture. As with many cultures, there are almost always subtle undertones in both casual and professional banter between people, which is why as effective as Zoom and video meetings go, nothing can truly replace the relationships built with in-person meetings.
Most of us would later on in our jobs apply these valuable learnings when we took on regional roles or help overseas and local companies in their expansion within China. Starting and running a business wasn’t the same as how most of the world saw it being done in the case of Facebook, Google, Apple or Amazon. The venture capital ecosystem in China didn’t really take off until maybe 10 years ago and the check sizes weren’t that large as well. Most of the time, it takes years for a company to grow, often staying in plain sight, having the right handshakes, playing by the rules of the game, and perhaps more importantly, having very very deep pockets.
Even as you are reading this, the geopolitical and macroeconomic landscape is constantly evolving, and we are still learning. There is certainly much more transparency today as compared to before, but the perspective of risk will continue to be an evolving and ongoing education process, and many investors and corporates seeking to do business in one of the largest economic powerhouses in the world will eventually need to find a way to balance expectations and reality.
More than ten years ago during my early IBD days, I was chatting with a friend over lunch. At that point of time, I had just purchased my house and the economy was gradually recovering from the shock of the 2008 financial crisis. In the midst of our random conversation, the idea of living debt-free came up and I told him:
My ultimate objective is to pay down all the debt in my property as fast as possible.
He sounded surprised.
Having studied and worked in finance, the common understanding was that every business had an optimal capital structure, which meant that returns could (and should) be maximised by the use of leverage, assuming that leverage was cheaper. As a fledging investment banker, it sounded stupid that one would not make use of this simple knowledge of using debt to improve your return on investment.
To add on, at that point of time, central banks around the world had also launched what was called “quantitative easing” - which kinda meant cheap money for all. Governments all around the world were basically throwing money into the economy to stimulate consumption and investment. Leverage was cheap.
In those years, the trajectory of the Singapore property market also favoured this hypothesis, allowing many people to maximise their returns in real estate investment i.e. any fool could make money through property. The construct was based on a few simple ideas:
Real estate has traditionally been a good store of value. In fact in Singapore, one could potentially even make outsized returns.
Cost of borrowing is low. Singapore government does a relatively good job of maintaining the city’s status as a prime financial center, attracting a lot talent, which in turn encourages foreign investment and economic activity, which translates to lots of liquidity chasing investors and home buyers' money.
Employment stats are healthy. A stable socio-economic environment allows the working class to comfortably service their mortgages. All else being constant, and assuming a steady increase in property prices, even the average household can be an asset millionaire after 30 years.
Because it seems like a no brainer, a lot of people are puzzled at why I do not put more money to work in real estate.
We bought our house on the secondary market in 2011. It was a relatively pricey purchase, especially when you compare it with the remaining leases and state of facilities of the new developments. We could afford to buy the new developments, and on hindsight, those would have also possibly paid off more handsomely today if I had "flipped" it in the market. Had I taken leverage, the returns would even be magnified.
But I did not regret my decision:
If you own one property (assuming you need to stay in that property), it's almost impossible to achieve outsized returns i.e. if you sell high, you have to buy high. Fortune in property investment only favours those who have more than one property or can afford to stay 'homeless' after selling their house.
The house that I live in is within less than a 2 km radius from my parents and parents-in-laws i.e. they are never too far away to visit.
The nearest MRT station is only a 5 minute walk (both ways once the Thomson East Coast line is open). In addition, I have direct buses to any where in the city area. And perhaps more importantly, because of these, I never need to set aside a hefty budget for owning a car.
There is good food all around - from the cheap hawker fare at Tiong Bahru market to artisanal coffee. Unlike most, I do not need to ‘travel’ and queue for these good food. They are basically just around my hood
The commute to the CBD takes me no more than 30 minutes door-to-door. Extremely convenient when I need to schedule meetings in town.
Sure enough I have the options of (i) paying off my home loan or (ii) re-levering to cash out some equity, but I see my current mortgage amortisation as a ultra-long-term rental arrangement without having to worry whether or not the landlord will jack up my lease and chase me out.
Buying or investing in a big house would have probably worked the same way too. We would still have solved for having a roof over our heads and potentially cashing out a healthy profit in the future. But going back to my first point above: when you sell high and cash out, you have to buy high as well.
Cash and the peace of mind is the oxygen of independence.
“The difference between what someone suggests you do and what they do for themselves isn’t always a bad thing. It just underscores that when dealing with complicated and emotional issues that affect you and your family, there is no one right answer. There is no universal truth. There’s only what works for you and your family, checking the boxes you want checked in a way that leaves you comfortable and sleeping well at night”
Whenever I approached the close of my financial modelling course, I always did a simple roll-call to call for feedback from everyone in the class. This time, instead of recycling this common practice, I decided to try out a different approach by using Mentimeter and getting everyone to input three keywords on how they felt about the last two days, and this was the result:
A million followers can't be wrong.
One of the key aspects of financial modelling is being able to accurately project cash flows. This has consistently been a perennial question that comes up - "how do we do it?", "How do we know that the numbers are reliable?", and of course the occasional remark from the seasoned industry veteran: "the assumptions are too conservative, I think it should be much higher!"
Subject matter experts and experienced professionals who have been in the game for a long time play an influential role in terms of how we rely on an estimation of the future. In today's context - given the speed and digital pervasiveness of information - the loudest person in the room can also sometimes be easily misconstrued an industry thought leader.
“Facts can be so misleading, but rumors, true or false, are often revealing."
Before we had the TV, email and newspaper, people relied on word-of-mouth as their primary source of information. Casual banter amongst households within proximity was how we passed the word around.
There was usually nothing lost in translation and no one usually questioned its legitimacy. That playground of information is so different today. Part of how we receive information today has evolved to include social media channels, such as Twitter and LinkedIn. We no longer need to hear information directly from the proverbial horse’s mouth. It is incredibly easy to be swayed by the opinions of the majority, albeit online or offline. After all a thought leader with a million followers can't be wrong right?
“Be wary of self-proclaimed and crowd-proclaimed experts. It’s less likely that experts will be mimetically chosen in the hard sciences (physics, math, chemistry) because people have to show their work. But it’s easy for someone to become an overnight expert on “productivity” merely because they got published in the right place. Scientism fools people because it is a mimetic game dressed up as science."
"The key is carefully curating our sources of knowledge so that we are able to get down to what is true regardless of how many other people want to believe it. And that means doing the work.”
Projecting cash flows is a work of art.
You would be almost be certainly wrong if you think that the ability to project cash flows requires hard core quantitative and technical skills. Valuation and financial modelling is really part art part science. In fact I would even go further to say that a large part of it is art, since the desired outcome is almost always based on creatively imagining what the future beholds.
The narrative, so to speak, is as important as the numbers. As Yuval Harari puts it in his book:
"A person who wishes to influence the decisions of governments, organizations, and companies must learn to speak in numbers. Experts do their best to translate every idea into numbers."
And so, the process of constructing a financial model tries to achieve this.
I often get asked if I could provide excel templates for a variety of sectors that people could use to just work off, punching in the inputs to generate the valuation output. Unfortunately, I don’t think it works that way.
The real value in any financial modelling exercise is not the result it produces, but the mental exercise that you have to go through in order to produce a functional three-statement spreadsheet of intricately connected moving parts.
This is probably the same parallel why people run marathons - not to get from point A to point B but more so the journey, the process of having gone through first hand and pain of completing 42.195km and that personal feeling of having achieved something at the finish line. That sensation means something different to everyone.
The financial model is a representation of what you think of the business and possibly how you see it evolving over time. In the hands of another person, the model assumptions and outputs might look very different.
As Warren Buffet once famously said:
"The forecasts may tell you a great deal about the forecaster but they tell you nothing about the future."
Whatever someone wants has value.
Going back to the narrative, the valuation exercise is always all about that magic number and the story behind that number.
It is easy to play around with numbers, crunch the numbers and as a lot of bankers say - massage the numbers. Numbers are freely available nowadays with the Internet and relatively cheap access to that information.
Stories on the other hand are a reflection of the CEO’s ambition and the company’s vision of the future. In the modern and evolving digital world, social media has increasingly found its role as a facilitator of information (both true and fake), and does an incredibly good job of amplifying stories.
Just look at GME.
The boring brick and mortar retailer was reportedly shuttering stores in 2019 and went into a semi-crisis when revenues plunged in 2020. Yet, its share price defied everything the numbers were saying, becoming a cultural sensation on social media.
If you looked at Lehman Brothers' balance sheet back in 2008 they actually had "one of the strongest capital and liquidity positions the Firm has ever had". But the story unfortunately went sideways, souring sentiments very quickly, resulting in its shocking collapse, disregarding whatever the fundamentals and numbers were showing.
Cryptocurrencies and NFTs are also classic examples of how story-telling has manifested in valuation.
There is almost no means of proving why a digital image of a monkey could be worth thousands of dollars. There is also no real use for a digital monkey, and therefore, no way of doing a meaningful DCF valuation.
NFTs are simply worth what they are because people say so and because people want it.
You can’t model sentiment and emotion in a spreadsheet. You also can't do an analysis of the cost-benefits on waging war for national security. Neither can you put a price tag on human relationships. The numbers simply won’t stack up.
"The concept of economic value is easy: whatever someone wants has value, regardless of the reason (if any), and its value is higher the more it is wanted and the less there is of it."
Storytelling for what it is, is a persuasion exercise to galvanise interest and to sell something - an idea, a product, a call to action. But it remains effective only to the extent others believe and identify with it. Any story becomes instantly more believable if there is sufficient information and that the anecdotal evidence provided is relatable by the other party - which explains also why investor targeting strategies are different for retail punters and large institutional buyers.
Without connecting the numbers to a story, projecting cash flows simply becomes an emotionless exercise of numbers.