Everything in your daily life affects your psychology and investment decisions in a hidden but profound manner, from hearing the increasing numbers of confirmed Covid cases in your locked-down neighborhood and the unfolding of turbulent global events to watching the sharp fall of stock market and the intense “grocery-run” on your phone apps. 

All kinds of negative news hit the investors’ nerves in first quarter this year. Russia-Ukraine War, soaring oil price, global inflation, FED rate hike, western countries’ sanctioning Russia, China ADR delisting warning and decelerating of Chinese economy growth. Those combined pressures causing the stock market experienced the largest quarterly drop over the past few years, which resulted in big drawdown of hedge funds and in turn triggered a few fund liquidations. Even renowned asset managers are under harsh questioning of investors.

Many investors felt riskier during such volatile market and fund subscriptions froze up. From Behavioral Finance Theory perspective, due to Recency Bias, human beings tend to pay more attention to events happened recently and depend more on recent fact (than it deserves to) to make a decision, or sometimes, just simple linear extrapolating to predict future. So that the more the market falls, the bigger risk perceived and the more pessimistic majority investors become.

The reality is the exact opposite of this feeling. The market’s up and down is a reflection of the perceived risks, not necessary the actual risks. The daily movement of the share prices is continuously reflecting investors’ future expectations, but not the actual facts. When the market is strong and the majorities are optimistic, the perceived risks are low, but it’s usually the time when actual risks are pretty high. When the market is weak and the majorities are pessimistic, the perceived risks are high, but it’s usually the time when actual risks are fairly low.

We believe the current market risk is actually decreased, rather than increased. Looking back at the peak of the last round market cycle, it was in Feb 2021 when CSI 300 index was at 5900 points. One year later, CSI is now at 4200 points, 30% lower than the last peak and many stocks have lost 50% since then. Most companies’ fundamental remains the same, but the valuation is 30% cheaper now. Which investment risks are higher, one year ago or now? When the perceived risks by the majorities are higher, the actual risks are lower.

The “Policy Bottom” has been confirmed. On 16^th March 2022, the market rebounded sharply upon the prompt comments and positive signals given by State Council’s Financial Committee Meeting on a variety of issues concerned by the investors, ranging from monetary policy direction, property developers’ liquidity risks to China ADR delisting. On 29^th March 2022, State Council Regular Meeting further concluded that “we are committed to the original full year growth target (5.5% for 2022)”, “policies to stabilize the economy growth will be announced early and quickly, while policies that unhelpful to stabilize the market will not be pushed forward.” The government is clearly honoring the “Policy Bottom”.

The current market’s valuation is close to the lowest point in 2018 and further downside is limited. In 2018, China stock market went through a whole year’s retreat as China-US trade conflict escalated along the way and CSI300’s consensus forward PE hit 9.8x at the end of 2018, which also marked the beginning of a bull cycle in the following years. The current CSI300 consensus forward PE is about 10x, close to its 2018 low. The support from the valuation will become stronger as the market goes lower from here.

The more volatile the market gets, the more need to stay fully invested. It is not easy to overcome the natural risk aversion during the market turmoil to increase fund subscription and to stay fully invested. It requires a clear and logic understanding of investment psychology and market behavior. It requires even more psychological resilience on Fund Managers when facing the NAV drawdowns and the investor challenges.

When the market fell sharply this year, most of our products had positive return. Throughout 2022Q1, we stay fully invested. Our holding onto the value-stocks enabled us to face the drastic market shift calmly when the market rotated in favor of Value Style. None of our products triggered liquidation even during the worst days of the market sell-off this year.

Not only did we stay fully invested, we also took opportunities to increase investment in growth stocks based on “the second investment perspective” that mentioned in previous quarterly letter. The portfolio now consists value-stocks as majority plus some growth stocks.  As the overall market’s and especially the growth stocks’ valuation declined since the beginning of the year, the timing to increase our investment based on our second bias perspective had come to maturity. Starting from the end of Feb 2022, while keep our core positions in Banks and Real Estate Developers, we added exposure in fundamentally improving Coal Mining sector as well as high growth sectors, such as Mining, Internet, Materials, Chemicals, IT and Health Care. The stock ideas came from the research effort we accumulated over the past few years. We believe this adjustment of sector exposure will bring more balance and flexibility going forward. We will continue to monitor and adjust stock selections based on future market conditions.  

We would like to emphasis that in order to harvest alpha, the more volatile the market gets, the more need to stay fully invested; the weaker the market gets, the more need to proactively generate stock ideas. We are unable to alter most of the unpleasant events in life and in the world, be it war or pandemic. But we can try think rationally, overcome the interference from emotions and make less mistakes in investment. Holding onto the right convictions and positions when the market falls, you will eventually be rewarded by the sense of validation and ensuing gratification.