Long read: Global Value Investing in Our Era

Li Lu attained iconic status in value investing circles as the fund manager who earned the trust and respect of the legendary Charlie Munger to manage his family money. A couple of years ago, we featured a piece in the FT that detailed his remarkable life journey beginning with losing his parents in Mao’s cultural revolution to being a student protestor at Tiananmen square and finally taking asylum in the US, where he embraced capitalism and practiced value investing. But this piece is from his recent speech at the Peking university. His previous two speeches at the university from 2019 and 2015 years ago have been widely read as well.

In his speech, he talks about evolution of civilisations and economies through history and where does China stand today and headed in that context. He ends the speech with a section on value investing in the current era. We feature excerpts from both, but they don’t do justice to this fairly thought provoking speech which should be read in its entirety.

Lu talks about evolution of market systems from Venice to Netherlands to Britain to finally the United States before invoking Adam Smith:

“The modern market economy has been operating for four to five hundred years, and some of these consensuses no longer need to be discussed, doubted, or arbitrarily criticized and denied. These consensuses were first summarized by Adam Smith in The Wealth of Nations published in 1776. At that time, he observed that the market economy system had gradually matured from the Netherlands to Britain, having been in practice for one to two hundred years. He saw that although human nature is inherently selfish, the greatest aspect of the market economy is that through division of labor and free competition, it transforms the pursuit of individual self-interest into societal benefit. This is done by achieving the optimal allocation of social resources and promoting continuous economic growth that benefit all social classes to help promote upward mobility between classes. The ideal of “everyone for me, and I for everyone,” has actually been realized through the market economy. The market economy system, through the incentive mechanism of “everyone for me,” has achieved the social benefit of “I for everyone….This system is certainly not perfect, but among all the imperfect systems invented by humans, the market economy is undoubtedly the greatest system invention.”

This is one of two things he recommends China needs to implement as opposed to the current inefficient system of relying on state owned banks for capital allocation:

“The system of credibility generated by the modern capital market is something a state-controlled banking system cannot provide, and it is not something banks can or should do. Banks cannot take on the role of making risk investments; if banks were to do risk investments, people would not feel secure putting their money in banks, and then banks would not exist. Public companies like NVIDIA are able to be born and grow because of modern capital markets, which aggregate small savings into capital through a system of intermediary institutions with credibility. This system also incorporates legal systems, best practices, dispute resolution mechanisms, historical practices, and long-accumulated trust. Currently, in China, only Hong Kong’s capital market has all the elements of a modern financial market system. If the market’s independence cannot be ensured, then it cannot operate effectively. The reason Shenzhen was successful back then was because of its independence as a special economic zone. To make good use of Hong Kong, at least in the capital market and legal areas, the promise of “fifty years of no change” must be honored. Credibility and trust in a system take a long time to build but can be broken quickly by only a few actions. Hong Kong’s market and system need to be cherished and protected, but the premise is to understand its importance”

The second thing he recommends China should ignite to achieve sustainable economic growth and successfully make the hard transition from middle income to the rich world is personal consumption:

“The biggest driving force comes from the proportion of personal consumption in GDP. This is the most organic, self-perpetuated, sustainable economic growth driver; everything else serves it and is not sustainable. What is sustainable are people’s continuous, increasing, and new desires. That is the most enduring, most innate, and always limitless growth driver in the market economy. Today, personal consumption in China accounts for only 40% of GDP, but up to 50% savings can be converted into fuel to power economic development, into new services, new products, and the birth of new enterprises. China has the best entrepreneurs, the best engineers, the largest unified demand and supply market, credible investors, and the ability to attract global professional institutions on the credit system supply chain. These advantages provide enormous potential to achieve organic and sustainable economic growth. By contrast, personal consumption in India accounts for 60% of GDP, ensuring sustainable growth; in the United States, this proportion exceeds 70%, and its growth is also sustainable. Once China enters this stage, its growth will also become sustainable.”

The last section of his speech on value investing in the current era summarises the five principles of value investing from Benjamin Graham, Warren Buffett and Charlie Munger:

For those unfamiliar with these, Lu elaborates on them. He then adds his own sixth principle: “Wealth is the proportion of purchasing power in the economy. The goal of value investing is to hold shares of the most dynamic companies in the most vibrant economies to preserve and grow wealth”

He elaborates on what he means by this as: “…as the entire economy grows, your wealth naturally increases. If your share increases, it means your growth exceeds the average. Even if the entire economy shrinks for various reasons, your wealth continues to grow as long as your share increases. With this understanding of wealth, you will better comprehend this statement: the macro is what we must accept; the micro is where we can and should make a difference. Maintaining this awareness allows you to calmly hold shares of the most creative and excellent companies without being shaken by macroeconomic fluctuations. Being able to sleep at night enables you to firmly hold your stakes, your purchasing power. This is why we first discussed the macroeconomic topics, but ultimately, we return to the core of investing.”

He ends the speech with a tribute to Munger:

“Until the last moment, his life remained calm and focused, dedicated to the work he loved most and he never stopped. Such a life is inspiring and uplifting for us all. Mr. Munger, through his life and over sixty years of investment success, taught us an important lesson: the macro environment is what we must accept, and the micro environment is where we can and should make a significant difference. Engaging in value investing allows us to breathe in sync with the times and grow alongside it. I firmly believe that those who are passionate about value investing, no matter their location or the challenges they face, can achieve meaningful results. I sincerely hope that everyone will continue to devote themselves to this wonderful endeavor.”