In life, sometimes we go through a series of periods between lack information and too much information, thus our perspective and thinking are not correctly formed and clear to answer important questions. When I started to work at Vietnam Investments Group (VIG), when joining any deals, we research everything possible about the market, competitors, changes in industrial structure, etc. Results of those studies are a series of information about everything we think we can possibly have, including public information and private information. I typically end up having a lot of information but not knowing how to arrange and prioritize them correctly. Deciding to invest or not is a difficult matter and there are many dimensions to consider back and forth. Market position? High net asset value over low valuation? strong management team with 20 years of experience and had engaging into the business 5 years? What are the key factors to decide to go or kill a deal?
This is, again, is a complex matter, however in this article I provide a facet that has a tremendous influence to the investment process.
So, what is the most important thing to an investor?
I coincidentally come up a similar question that open my mind in finding what is the most important thing: What is the most important thing to a salesman?
In business, I feel that businessmen have to create jobs, pay government budgets, be leaders, solve social issues (and success will follow). In investment, I feel that investors have to see the big picture, invest into the right teams and right projects (at the right time), push the world to the next edge (such as investing into Facebook and Google), and consult to investee management. On the contrary, the sales perspective is very clear-cut: You sell the product, or you don’t, period.
What is the most important thing to a salesman? – Successfully sell the product.
So, what is the most important thing to an investor? – Optimize returns over acceptable risks.
There are two dimensions: (1) optimized returns in the relationship to (2) the level of risks absorbed with that particular investment channel/strategy. Previously when thinking about this matter, I only think about returns. The more time flies by (with additional painful experience) the more I understand risk management is a natural counter-part with optimizing returns. To the very end, my view about investment is establishing a sound investment strategy and optimize risk management. The last perspective is more active on risk management rather than active on finding the next killing opportunity. If the investment process is sound, it will automatically generate profit, then I will be conservative and preserve previous capital.
When looking at an investor under this perspective, I have a more matured view about different investment classes. Previous, I think Private Equity (PE) and Venture Capital (VC) are more cool comparing to bond fund and pension fund. The key reason is when I work on PE and VC I have the feeling to join into projects that can change the industry, economy, and create something completely novel and push the world to the next edge. That’s certainly interesting, however, even the institutional investors or sovereign funds when they invest into PE or VC firms they want the fund managers to answer the most important question to an investor: will the fund optimize returns over the risks absorbed? Else, changing the world is not too much of a matter. Under the global investor perspective, they pay attention to optimizing the capital they are managing. If the world is shaking, possibly they will quickly forget high-tech companies that are bringing humanity to Mars (such as SpaceX of Elon Musk) and allocate capital into governmental bonds of major countries. If the world is prosperous, they may sell bonds and invest into PE or VC in emerging markets. If fiat assets seem particularly challenging, maybe they will strengthen their positions into gold and real estate. Under the global investor perspective, companies, countries, precious metal, houses, paintings are asset classes for them to optimally utilize their capital under different investment environments. It will certainly be illogical to think that these global investors would invest into a PE or VC that the firm itself doesn’t utilize those capital to achieve the global investors perspective.
Below is the performance of certain asset classes and major funds in the world during 2001-2014 period that my associate has studied when we had conversations about different assets classes with different investment strategies:
If I stick with things that are not important to an investor (such as cool or changing the world) maybe it will be difficult for me to accept the performance of VC in the past 15 years have only been about 2.76% annually. That would be lower than performance of pension funds that index their portfolio to Dow Jones composition (4.97%) or S&P composition (7.07%). Actually both VC and start-up (two close but different industries) distribute their returns in a very skewed manner comparing to normal distribution, in which there are a few VC and start-ups have a major returns and most go into losses or bankruptcy (hit-driven characteristic). Besides, VC can decide if they want to public their records (self reporting bias), leading to evaluate performance of this asset class is somewhat incomplete, adding to further barriers such as providing self reported interim valuation of portfolio (before sell off the investee or calling the next round of capital) or only the winning funds provide the records (survival bias).
Return to due diligence issue so that we (VIG) try to decide if we invest or not, under optimally utilize capital perspective, we will consider thoroughly the upsides and the downsides. Overall, when investing into a listed or a private company, it is similar that the investors have to have certain clues on how the cash will flow back to the investors. There are generally two ways, the first is dividend, the second is capital appreciation (sell the stock). Thus, before engaging into a deal, an intelligent investor has to think about how she will sell that company (IPO or trade sales, to whom?) with what kind of valuations under scenarios. For example, if during the due diligence process the investors see a potential company with strong management team but also see an unclear vision on how to divest the company (for example in the next 5 years, this industry might come to saturation phrase with many similar companies go into bankruptcy due to a massive over-supply, and the remaining companies have to liquidate or sell itself cheaply), the fund will be clearly cautious. Under this view, the investee is a “product” and the fund is “salesman”. What is the most important thing to a salesman? Should the investor invest if later on the “salesman” cannot sell its “product”? Or sell with a loss?
Therefore, to evaluate a deal in line with investors’ thinking, first thing to consider is how would the deal return? how would the risk unfold? Not about market position of the investee or CEO’s experience. After identify factors that can answer those first two questions, the investors go deep into those factors and further analyze them: where superior returns come from? is it a good company? and are there clear exit routes? Then further into deeper layers to identify company’s valuation, what formed that valuation, and how the fund can add value to maximize factors that enhance the investee valuation and protect against the investee weaknesses after the investment is made.
This article (Vietnamese) is originally posted on Timo.vn (Link) on December 3rd, 2015
Special thanks to Thai Hoang has prepared the asset classes performance in 2001-2014.
Dow Jones: 1stock1.com
London Gold Fix: Kitco
PE – Leverage Buyout: Preqin
Berkshine Hathaway (Class B): 1stock1.com
Soros Fund Management: 13F-HR SEC Fillings
SAC Capital Advisors: 13F-HR SEC Fillings
Paulson & Co: 13F-HR SEC Fillings