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"Uninvestable" is all about the perception of risk

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.

Shan Weijian summarized this aptly in an interview last year:

"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.

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