Q&A With Li Lu
Li Lu of Himalaya Capital spoke in November 2019 to students at Peking University’s Guanghua School of Management. His speech was titled “The Practice of Value Investing”, and followed-up from the speech he gave five years earlier titled, “The Prospects for Value Investing in China”.
Li Lu published the official version of his speech in his book, “Modernity, Value Investing and China” (“现代化、价值投资与中国”) and included a record of the Q&A session which followed. Below is my translation of that conversation.
I hope you learn as much from him as I did.
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“The Practice of Value Investing”, BY LI LU
NOVEMBER 29TH, 2019
Q&A:
1. I’ve been a sell-side analyst for more than ten years now. What challenges do you think there are for me to become a value investor? How do I get in? Can you teach an old dog new tricks?
Li Lu: Switching from the sell- to the buy-side requires a change in mindset. I have a business owner’s mindset because after I bought my first stock, I thought the company belonged to me. This is human nature: we think the things which belong to us are special. It’s similar on the sell-side. If you’re incentivised to pitch a certain stock, you’re always going to be inclined to put lipstick on a pig – perhaps even to describe it as a unicorn. Of course, you might be responsible for pitching a company that is fundamentally sound in the first place, like Moutai. But you will still have the mindset of wanting to pitch it and make the sale. As they say, “He who pays the piper calls the tune” – and this is very hard to change. Because if you didn’t act this way, you wouldn’t fit in and [wouldn’t be able to progress your career]. The problem is that many folks who transition from the sell-side to the buy-side can’t shake off their old mindset – they can’t stop selling. They’re so good at it that they’ve [fooled] themselves. I’ve seen this many times with friends who worked in investment banks but who never really succeeded as investors. People are like this. [As Richard Feynman said], “you must not fool yourself – and you are the easiest person to fool”. When you are able to sell something especially well to other people, it’s usually because you’ve persuaded yourself too. This is why I see the most important thing is to stay objective and rational.
How do you stay objective and rational then? You must change your mindset. I therefore think the best thing for you would be to spend some time making investments on your own account. Feel the difference in psychology [between pitching and owning]. After a while, you will really feel that these companies belong to you. Your frame of reference will begin to change dramatically. The way you gather information will change. It’s like your antennae changes direction. And once it does, you will realise that the information you gather is different too.
This is why I think the first step must be to change your mindset. The best thing for you to do before becoming a professional value investor is to make some investments on your own account. But you must do so as a value investor and not as a sell-side analyst. A sell-side’s analyst approach is to talk up whatever it is they want to pitch. Because if you don’t, you won’t succeed on the sell-side. When you meet an insurance salesman, they’ll always want to recruit you as a ‘down-line distributor’ (i.e. a subordinate in a multi-level marketing scheme). Why do they see everyone as a potential recruit? Because this is the only way for them to succeed! Therefore, the most important first step for you is to change your mindset. When you feel like you have, you will be on the road to leaving behind the shackles imposed on you by working on the sell-side.
Your knowledge of business and companies will still be useful, however, and something on which you can build. When you use your owner’s antennae to re-organise all this information, you will find you’ve tuned into a different channel. You will still posses your original knowledge base but the way you organise it will change in a subtle and important way. Unless you go through this process, it will be very hard to transition directly to the buy-side.
2. Studying mistakes can help us understand success. Have you seen any determined young people fail in the end as value investors because they were unable to stick with it? Even if they possessed the temperament you described earlier? If so, why do you think they failed?
Li Lu: I’ve seen many different people fail for many different reasons, the most important of which is passion. For someone to stick with something and get good at it, they must be interested and passionate. The easiest way to succeed is to be passionate about something and good at it. Say for example you have someone with a value investor’s temperament but who is more passionate about other things. After studying value investing for a little while, they will turn their attention elsewhere. This is totally understandable and actually quite reasonable. In my opinion, the most important thing isn’t to think about in which pursuit you can earn more money. Because if you do, you’ll always be jumping around since there will always be people who earn more money than you. If you measure your life based on how much money you can earn, you will always be miserable. You must therefore follow your passions. If you are interested in value investing, you will go further the longer you stick with it. But you won’t stick with it if you’re not really interested. That’s been the case in the majority of instances I’ve seen. Of course, the things you learn as a value investor can be useful elsewhere provided you have the right temperament.
3. How do I know if I really understand a company? Is there an objective benchmark to test my understanding?
Li Lu: We’re in the business of forecasting. So determining whether you understand a company or not is simply a matter of assessing whether your forecasts were right or wrong. However, the answer won’t immediately reveal itself. You’ll have to wait many years to get it. If you are intellectually honest, you will insist on knowing the answer and so will naturally learn if you really understood or not. I hold my employees to a standard: if they really understand a company they’re researching, then they must be able to say what will be the worst case for that company after ten years. The best case scenario will usually take care of itself. You must therefore understand what the worst possible case could be after ten years. If you can’t do that, then you can’t really say you understand the company. But if you can, your forecasts you should have a very high chance of proving correct. And you must go back after ten years to see if you were right.
This is therefore a very hard question. How come? Because people possess many cognitive biases. Charlie Munger listed 25 of these cognitive biases in “Poor Charlie’s Almanac” and there may be even more in reality. The reason they exist is because our minds are the product of natural selection, and their main function is for us to survive and procreate. However, our living conditions today are the result of cultural evolution. We live in a civilised society, many of whose rules do not fit with biological evolution. As a result, many of our innate cognitive biases serve us poorly, making it hard for us to be objective and rational in our judgement. This is why we will encounter the problem raised in this question in our studies and research. You might think you understand something but you don’t understand your innate blind spots, nor the way they mislead you into a view which ultimately proves wrong. In other words, you didn’t actually understand.
So when you think you understand something, you must first understand what you don’t know because our knowledge is limited. The most important concept in the circle of competence is its boundary. It is a bounded circle. If you do not know where its boundaries lie and believe you know everything, then you certainly do not. You also need to understand that when you know something is right, you must also know when it will go wrong. Munger has a standard which I think is immensely useful. He says that if you want to hold an opinion, then you must be able to refute it better than the smartest person you can find who disagrees with you. If you can’t, then you don’t deserve to hold it. This is a good standard which you can use to judge whether you really understand something. If you can do this, then there is a chance that you understand this thing.
But you must know when your understanding is wrong. In other words, you must know that your competence is bounded. If you don’t know the limits of your competency, then you can’t possibly understand as there is no way you understand everything. This sounds a bit abstract but it will be very clear once you have a specific question. There are some colleagues from our company here today and each one of them has gone through my questioning. My questions will push you to your limits and if they don’t, then there’s no way you really understand something. This depends on intellectual honesty and requires continuous training. It is very hard to do immediately. Without this way of thinking, it is very hard to develop a true understanding of something. But if you can develop the habit, it will stand you in good stead for the rest of your life.
4. You just spoke about how to achieve real understanding. You also spoke earlier about how value investing is a learning process. Could you please talk a bit about which learning methods can help us compound our knowledge?
Li Lu: Knowledge must fulfil several basic conditions to be considered useful. First, it must be able to be verified. It must be supported by logic and the facts you can see for yourself. Moreover, it should confer a high degree of explanatory power. At the same time, it should be helpful for making predictions. When we look at real life, it is scientific knowledge which best meets these standards. However, many of the phenomena we encounter in real life have no foundation in scientific theory because they relate to people. And in the case of people, we must think in terms of a distribution of probabilities. When you study mathematics, statistics is far more important than calculus, so you must study it well. This is because virtually all problems in the real world are statistical problems. Let’s go back to the question then. How should we go about studying real world problems? You still need to use scientific methods but you must understand that all you will get are rough results. Of course, it’s better to be roughly right than precisely wrong. And yet scientific methods remain the most effective means with which to compound your knowledge.
Another useful method is to let your passions be your guide. When you become really interested in something, you can accumulate knowledge about it faster, more effectively and better than anyone else. At the end of the day, you will be using this knowledge in a competitive environment. Your judgement must be better than someone else’s. When you’re really interested in something, you will keep pursuing it even when others have given up. When others are satisfied, you will keep inquiring. This is what will give you an edge. So in the end, the only reliable approach I’ve seen is to accumulate your knowledge piece by piece by letting your passions be your guide, using a scientific approach and maintaining intellectual honesty.
5. It seems there are two models for success in our circle. The first looks at the big picture and puts their trust in exceptional companies run by honest managers. They then step back completely and let management do the work for them. The second hopes to understand the company even better than management itself, with nothing too big or small. What do you think of these two styles?
Li Lu: These styles are actually both a part of acquiring knowledge. The quality of management is a big variable for companies. When a company is in its early stages or growing rapidly, its founder and senior managers have an enormous impact on value creation. This is especially true when we look over a long time horizon – and the longer the time horizon, the more important this becomes. However, many companies are driven more by the competitive dynamics of their industry, not any single person’s determination. No matter how good someone is, they will not be able to produce exceptional results in a terrible environment. However, even a person of modest abilities can produce exceptional results in the right settings. For example, there are some exceptional [Chinese] state-owned enterprises whose senior managers have no experience doing business. And yet this in no way impacts their ability to produce good results. Each industry’s conditions are different and must be analysed on their own merits. However, the standard we use should be the same: your knowledge should allow you to make reasonably accurate forecasts with a high degree of certainty about what conditions will be like many years in the future. No matter how you go about doing it or from what angle you look, you must cover each and every aspect. If you want to understand a company, you must understand its management and the basic drivers of its industry. This is one of the reasons why value investing is so hard: there are many, many things you must understand.
This is therefore why we must have a margin of safety. I haven’t talked much today about this concept but the reason we have a margin of safety is because our forecasts are limited, as is our knowledge. If you have a sufficient margin of safety and enough protection in the price, then you can still make a lot of money even when you don’t fully understand something. Why did I raise the example I did during my lecture [of the cable company]? Even though I knew next to nothing about its business using my standards today, I got very lucky and made many times my money. But I only invested because I had a margin of safety. And after I invested, I went on to learn many more things. The margin of safety is therefore especially important. When the future isn’t clear, you must choose those opportunities which are especially cheap. And when you are choosing amongst multiple opportunities, the bottom line is that they should be cheap.
6. Can you please tell us what are the most important sources of a company’s moat? Is it a brand, the management team or its business model? What types of moat do you value most?
Li Lu: This all depends on your investment horizon. The longer your investment horizon, the more important industry dynamics become for protecting your moat. The shorter your investment horizon, the more important people become.
The source of each industry and each company’s competitive advantage will be different, as will the degree to which they can protect their moat. We hold ourselves to the same standards and use the same analytical methods when looking at each industry. However, after spending much time on our research, we ultimately reached the conclusion that most companies are too hard and predictions about them cannot be made. The changes in many companies themselves do not make for sustainable competitiveness. Take the simplest example, restaurants. At any time, there will always be a group of restaurants in Beijing with the best business. And some cuisine will always be the most popular. However, you will see that after not too long, these will change. Because even though they’re doing well now, it’s hard to guarantee that they will still be in the future. You can spend a lot of time on industries like this and ultimately realise the same thing: they are too hard to predict.
So speaking for myself, I put all of my efforts into looking at industries about which predictions can be made. Within these industries, I then look for exceptional companies – and not just exceptional because of their industry but on their own merits. I define exceptional as having returns on capital well in excess of their competitors. Within these companies I then look for things which really interest me, which I think I have the ability to research or which are already within my circle of competence. The companies which make it through this selection process are the ones I will then go and spend time on. There are about 100,000 listed companies around the world but you shouldn’t ever try to study more than five to ten at a time. Your most important work is therefore to find a way to cut this number down. There are many things you can ignore and many which are outside your circle of competence. The most important thing you can do then is to ensure that when an opportunity comes up which is within your circle of competence and fits, you don’t miss it! But if an opportunity doesn’t fit, you can completely ignore it.
Go back to what I said at the start. You must understand yourself relatively well and then you can be picky in your choices. Once you understand a company, you can just sit and wait until an opportunity comes when the price gives you sufficient margin of safety. At that point, you won’t lose money even if you’re wrong. This is when you can go all-in. This is why you should focus your research on things that you can understand well and understand clearly. And since you will only be choosing a few companies, you might as well choose the very best ones. Of course, you can also choose the smallest companies or those whose price is already cheap. If you understand them well and there is sufficient margin of safety, you will not lose money. In short, you want to invest in certainty and avoid uncertainty. When price can give you certainty, then price becomes the most important consideration. When your own knowledge, ability and judgement can give you certainty – especially when you have been researching truly exceptional companies – then you don’t need to constantly change your watchlist every few years. You can just keep going and let the companies own compounding do the work for you.
7. Thanks to your speech, we now know a bit more about the special traits a value investor needs – particularly in terms of temperament. Amongst the entrepreneurs on whom you focus, what kind of special traits do they possess?
Li Lu: I’ve been a generalist for some 26 or 27 years. I’ve seen both successful and unsuccessful entrepreneurs of all stripes. I’ve realised that market economies have a very special property: they can release a person’s true potential. Many successful entrepreneurs actually have all sorts of “issues” in their ordinary lives. Before they were discovered by the market economy, you might not have wanted to associate with them. And if they had been in another industry, the odds are they would have failed. However, a market economy can allow any special or uncommon person – any outsider – to ultimately succeed within their niche.
I’ve therefore never believed that someone who fits the conventional mould can become an exceptional entrepreneur in a market economy. The market economy enables people to set up businesses which reflect their unique traits, and then to go on to great success. For this reason, my conclusion is that there is no uniform standard for identifying what kind of person will go on to succeed.
At the level of the individual company though, it’s not just about analysing people. You can analyse why a person chose to build the company the way he did, and why that enabled its success. For example, Jack Ma [of Alibaba] might not have managed detailed operational matters. But he knew very well how to manage people and use them. The kinds of people he used would then be very focused on the details – like [Alibaba’s CEO] Daniel Zhang. Every person will therefore find the company which bests fits him. And when you are evaluating that company, you must not jump to the conclusion that because someone is like such and such, then the business will succeed. I’ve seen many people who tick all the boxes but whose businesses are very average. I’m sure you’ve all had the same experience. If you think about the people you know, I’m sure there will be some who are particularly talented and look like they have a lot of potential. But in the end, they don’t do particularly well. This kind of thing happens everywhere. I therefore think that every company must be assessed on its own merits, with proper analysis done on its own unique circumstances.
8. As a student hoping to enter the investment industry after I graduate, is it best to work for an institutional investor as my first step? Do I need to apprentice myself to a teacher?
Li Lu: When I was studying at Columbia University, I also attended a value investing class like this. At the time, Columbia was the only university to offer this type of course and Buffett would come once a year to speak. Someone would always ask him this question and he would always say, the best way to learn is to go and work for the person you admire the most. This way you will learn especially quick. After his answer, I decided to found my own company. Just kidding! The real reason I founded my own company was because I couldn’t find any other work.
No people are the same. Some people will learn faster under someone else’s tutelage. However, there really aren’t many people who practice value investing and so there aren’t many value investing firms either. Moreover, these firms don’t usually need to hire too many people. Take Buffett’s company, for example: it has more than 100 subsidiaries and employs more than half a million people but his head office only has about 25 people. Until seven or eight years ago, there were only two investors managing some USD500bn in capital: Buffett himself and Munger. It’s therefore hard to go and work for him. My company is the same and only has ten or so staff. So while it might be good to go and work for a value investor, the opportunity to do so is exceedingly rare – especially since the most exceptional investors seldom need to hire anyone. This is a paradox.
This is the reason why we started this class and also hope to found a community of Chinese value investors. We want a ‘whitelist’ of investors who have a long track record of independent results managing a single fund to a single style – not like those investors who launch a hundred or more ‘investment products’. We need to find these kinds of people. Then everyone will be able to see that these kind of results are indeed real and possible. If I had never seen Buffett in the flesh, my understanding of stocks would have been stuck on the impression I gained from [Chinese author] Cao Yu’s play, “Sunrise”. I would never have joined this profession. Naturally, I also wanted to work for Buffett. But he wasn’t hiring. Now, we also don’t hire people. I therefore think the best way to learn is self-study; that and having some contact with more experienced investors can go a long, long way.
I generally don’t speak in public, with the only exception to return to my alma mater, Columbia, to talk with the students of that same value investing class. Before this class was launched at Peking University, I had never given a lecture in China before; even today, this is only my second time speaking in China. Why don’t I speak more often? It has to do with investing and my own personal biases. Going back to the question on the difference between the sell- and the buy-side, it is our natural human instinct to sell. Everyone always wants to dress things up to seem better than reality, otherwise why would we spend so much on our clothes? Similarly, we always want to present ourselves as having superior knowledge and judgement. Humans have a bias towards self-aggrandisement which is very hard to change. And we intensify this each time we speak publicly, especially if it is about some specific stocks. It’s important to maintain a healthy scepticism because no one can ever be 100% certain. If you get to 80% or 90%, that’s already pretty good. But when you go out and speak in public as if you had 100% certainty, you fool yourself into thinking you have 200% or even 300% certainty. You lose even the slightest doubt in yourself. And the more you speak, the worse it becomes. This is why I generally don’t like to speak in public. There’s only one exception and that’s when I can speak with students – and that’s only because this is such a rare opportunity. I don’t talk about specific companies but can share my experiences.
So in summary, your first choice should be to go work for someone you admire. The second choice is to study by yourself, and in the process to also reach out to people you look up to. You must stay in touch with them. Classes like this are a good example; there are people here today who have flown in from all over the country – perhaps even some who have flown in from the US. It’s actually very helpful and I would certainly do it too if I were in your position. What we’ve discussed today should be especially useful in practice because after all, value investing is a practical art. Furthermore, value investing is a solitary pursuit in which you must be responsible for the decisions. If you add more people to the discussion, it will become a committee and you will lose your objectivity. Group dynamics will take over and impair your judgement. Our innate biases are an astonishing impediment to investing. Our minds have not evolved in a way which suits investing so you must train yourself. If you can work with a great investor, treasure the opportunity and seize it! But if you don’t, you can still make your own opportunities. At the end of the day though, self-study is the most important thing. You must experience these things for yourself.
9. I’d really like to go and buy stock in a cheap company to study it and learn more. But before I do, I’d just like to ask: what kind of margin of safety can research into a company’s balance sheet provide?
Li Lu: I can tell you are keen to buy a stock, or keen to research one and buy some more. Don’t get the order wrong though: do your research first and then buy. I think your question relates to companies with a low price to book ratio, right? In today’s market, there aren’t many stocks like that – except in Asian markets, that is. I assume you can invest globally. There are about 100,000 stocks around the world which are traded daily. In Asia, there are still many companies you can look into. For example, the company may be profitable now and for many years into the future. You can verify the value of its assets, be they stocks, financial securities or real estate. You can then subtract liabilities to derive a net asset value. If we say the NAV is 100, there are companies which transact at about 50. Although this kind of opportunity is more rare now than when I started, they still exist! It’s strange but the market always has nooks and crannies where you can find opportunities like this. If I was going to start again and didn’t know anything at all, I might well start here again. I can grasp the concept. I can see what I’m doing and even feel it. Even if I don’t understand anything else about the company, I won’t lose money this way. However, in today’s market and with the scale of money we manage, I can’t look into this kind of company anymore. So I’m not really an expert and I’m sorry to say that I cannot give you a satisfactory answer. I know this kind of opportunity exists in other markets but I really don’t know about China, apologies.
10. Can you please describe the experiences and traits which shaped Munger’s investment philosophy? As far as you understand, how was Munger’s investment philosophy formed?
Li Lu: First, many of Munger’s concepts were already deeply ingrained before he began investing. For example, he was already very interested in understanding how the world works – especially at a practical level. He wanted to figure what works in this world and what doesn’t, and studiously avoid the things that don’t. This had nothing to do with investing; it was just an interest he had pursued from childhood. On reflection, I was the same. Before I heard Buffett speak for the first time, I already had some preconceptions in my mind. For example, I already had a visceral dislike of speculation. So after I heard Buffett speak – even though I would meet a lot of them later – I never had any interest in those Wall Street schools of investment thought, the men of the hour or all those successful people. [Buffett has said that value investing is like a vaccine which either takes or it doesn’t. Buffett has never seen anyone – and neither have I – who began speculating, had an epiphany one day and then became a value investor. In any case, I haven’t seen a single example of this. The concepts which made Munger successful therefore took shape long before he began investing. These concepts then went on to influence Buffett. Because Munger was interested in whatever worked, he naturally became interested in exceptional companies. Because these companies had figured out what worked, their ability to make money was far better than those otherwise cheap companies.
Buffett worked for Benjamin Graham for two or more years early in his career and was profoundly influenced by Graham’s way of looking at things. Because Graham’s theories were mostly formed during the Great Depression after he had failed spectacularly in the years leading up to 1929 doing some investing and some speculating. After 1929, he drew lessons from this painful experience and began to systematise a new methodology, after which he began to perform better. Graham primarily practiced in the period from 1929 to the 1950s. After the market crashed in 1929, it took seventeen years until it recovered in the early 1950s. Graham’s career therefore spanned the most disappointing period of the American stock market. The stock market was in constant decline, not dissimilar from China’s A-share market. He obtained excellent results in this period but even he couldn’t scale his strategy. You can’t scale a strategy investing in what Buffett calls ‘cigar butts’.
Graham’s ideas made him very successful at the time and so he obviously had a large influence on Buffett. But when Buffett began investing himself in the mid- to late-1950s, America had already emerged from the era of the Great Depression. The economy was on the rise and those exceptional companies were just beginning to come into their own. For this reason, Munger’s influence on Buffett at that time was especially important. Munger had reservations about Graham’s theories from the very beginning. He wanted to figure out how the world works; what succeeds and what doesn’t. He then wanted to repeat what worked and avoid what didn’t. He never emphasised that these companies had to be bought at a discount because their excellence was in itself a discount as it would allow them to continuously surpass expectations. Gradually, Munger’s thinking had an enormous influence over Buffett. As Buffett matured, he therefore left behind the influence of the Great Depression and its method of survival. However, he never relaxed his requirements on valuation and margin of safety. From what I’ve observed of Buffett, these concepts are deeply ingrained. I think I’m also like this, which probably has some connection to my personal history. No one’s style is the same.
11. You said earlier that index investing can be a suitable choice for the average investor so long as the index reflects the overall economy. Assuming passive index investment funds continue to occupy a larger and larger share of the market, what consequences do you think this will have?
Li Lu: This is a very interesting question, although perhaps less relevant in China because index funds do not yet comprise a large part of the market. The situation is also different in China and the US. In China, because we haven’t yet fully implemented [an effective system of corporate disclosure], nor do we have a strong policy for de-listing companies, our indices do not fully or fairly represent the underlying economy. I think that the regulators will address this in the coming years. We have transformed from a manufacturing- and export-led economy into a consumption-led economy. In this new era, the means of financing may move from indirect finance to direct finance. The role of the stock market will grow in importance, and this will require attracting more and more people to participate in it. But if we want more people to participate, we will have to better control the market’s gambling and excesses, and increase the part of it which focuses on investment. The best, fastest and biggest way to do the latter is through index investing, which means making indices better reflect the underlying economy. One possibility would be to develop a good ETF to do so. But there are many man-made factors involved which make this not the easiest course of action. The best approach is to therefore use a market-based solution [and enhance regulation] so that the existing indices become more representative. This is China’s challenge.
America’s challenge is that indices comprise a higher and higher percentage of the market. When they reach a certain point, will indices begin to have their own positive and negative feedback loops affecting prices? The market needs investors because they are the ones who discover prices. If a market lacks a price-discovery mechanism, it will distort all financing. The biggest problem with passive investing is that it is price agnostic. What proportion of investors does a market need to be effective? This is the challenge currently faced by mature markets. Index investing hasn’t yet reached a level in America where it influences the process of price-discovery. However, if this trend continues, there is a possibility that investors are crowded out and the market loses its ability to discover prices. A lot of people are talking about this but I’m personally not too worried. Before the advent of index funds, the market always had a large element of speculation. Value investors were always in the minority. I look at value investors and fundamental investors separately here. The former are a sub-set of the latter but are pickier and demand a greater margin of safety. But otherwise, their thinking is similar. My suspicion is that these people have always been in the minority in the market. There was a Professor at the Columbia University School of Law called Louis Lowenstein who made a relatively systematic estimate of how many value investors there were in the market. He estimated at the time that there were about 5%, which wasn’t scientific but I haven’t seen anyone else yet expand on his work. But whether it was 5% or 7% or 4% or 10%, the proportion was not particularly high. So before the advent of index investing, these people had long been the most powerful force in the market. But while there had never been any large-scale disasters, bubbles remained an ever-present phenomenon. 2008-2009 was of course an extreme situation. But overall, I don’t think this will be a big issue for many years to come.
However, this problem does not exist in China. China’s problem is that today’s stock indices do not fairly represent the underlying economy. Furthermore, there is no alternative ETF. Whoever can create an ETF which better represents the underlying economy will make a huge contribution to common investors. The regulators must do more work on this.
12. Can you please share how value investing has shaped your thinking on health, family and life?
Li Lu: I’ve thought a lot about this question, and perhaps I’m not the best person to answer it. I’ve been divorced once and it wasn’t my choice to do so. So in this respect, I’m far from being a lifelong winner. However, I’ve kept a good relationship with my ex-wife and today, I still manage her money. So I’m far from being an expert in this field and you mightn’t get the best results if you follow me.
I think investing is a very long-term pursuit in which short-term results are not useful at all. The reason Buffett has won everyone’s admiration is because he has a track record approaching 60 years now. It’s important to obtain a long-term track record and one of the prerequisites for doing so is keeping in good health. Between Buffett and Munger, one is 89 and the other is 96. Their passion has not diminished, and they still go to work every day. I therefore think having a long life is the first important element of success. And if you want a long life, one of the most important things is to do something that you like. While of course you must maintain a good lifestyle and habits, you must also find serenity. If you look at Buffett and Munger, they just don’t get anxious. Because everything they do creates a win-win outcome, they just don’t feel any pressure. For example, 50 years ago, they set their salaries at USD100k each. And 50 years later, they are still paying themselves USD100k each. Imagine how much they could earn if they set a 1% management fee on the USD500bn they manage? Or how much they would have netted if they had charged a 20% performance fee? However, if they had charged these fees, they would have had constant pressure to perform. Likewise, they would have pressure from redemptions. And they never could have done as they please. Buffett currently has more than USD100bn in cash but has no pressure [to act]. He has arranged his life well so that he can live in Omaha. If you go there, he might come visit you. If not, he’ll just keeping doing what he does. He eats the same thing every day. He “tap dances to work”. And this is what has allowed him to accumulate such a long track record. Moreover, everything he does with other people is done in a win-win way. He wholeheartedly pays attention to other people. We’ve known each other for so many years, [and I can say that] he genuinely cares about other people. He genuinely goes out of his way to help them. He has no malintent. That’s not to say he doesn’t make judgements or that there aren’t people he dislikes – he just avoids awkward situations. He has arranged his life to be especially stable and especially sustainable – this is very important. This is to say that it’s very important to have a good family life and an environment in which you are surrounded by love.
It’s important to be well-intentioned with your colleagues and your friends, and no to have any ill will. Whatever you do, you must do it in a win-win way. We’ve never taken a management fee and don’t charge anything for the first six percent return. So if you earn an index-like return, you would never pay a dime to us. And on the money you earn over and above the index-like return, everyone hopes to make more money. On this, we borrowed Buffett’s early approach and fee structure – the Buffett formula. This allows us to live in a very stable way. I have no pressure, and this is very important. I could even come here and speak with you today. Our colleagues are all warm and cordial with each other. We are all very open and transparent, and shun any rivalry. The relationships we have with other people are all mutually beneficial.
We don’t beat ourselves up. We only do things we truly understand, and refuse to do what we don’t. In this way, we can act with no misgivings and avoid the markets ups and downs from affecting our emotions. You will only be able to accumulate a long track record if you can live this way. Having a calm mindset is therefore extremely important. It’s critical to turn your life and your relationships into ones of mutual benefit based on love. It is important to give back and to help others; in fact, this can help everyone to feel better and appreciate what they have. Buffett’s definition of happiness is, “to have the people I want to love me actually love me”. I think this definition is pretty good. Using this kind of method to arrange your life will allow you to build mutually beneficial relationships with people over the long-term. In turn, this knowledge can allow the capital you manage to accumulate gradually, allowing the people who have entrusted it with you to have the means to help others. We only offer our services to university endowments funds, charity funds and family offices focused on charity. We are very picky with our clients and do not manage money simply to make the rich richer. This is how we feel like we are contributing to society. If you arrange your life in this way, you will be more at ease and less anxious. You will be able to walk through life unhurried and at your own pace.
A lot of investors have told me that they want to invest like I do but their clients won’t let them because they’re always thinking about how much money they can make in the next hour or so. I personally think that you should not take these kinds of people as your clients. They then say that if they didn’t have these clients, they wouldn’t have any clients. And then how would they go about finding clients like mine? I didn’t have any investors when I started, only the money I had borrowed. My net assets at the time were negative. Munger likes to ask, how do you go about finding a good wife? The first step is to deserve a good wife, because a good wife is no fool. Clients are the same. When our fund started, it was my own money for many years plus some from a few close friends who believed in me. Over time, as you accumulate more experience and build your track record, suitable people will naturally find you. And amongst them, you can choose the most suitable. You can do it this way very gradually with no need to rush – and with no need to compare yourself to others. The most important thing is therefore to be able to let things come as they are. You must have faith in the power of compounding and the power of gradual progress. Compound interest is a gradual force: 7% compounding over 200 years will give you a return of 750,000 times, right? That’s not too bad at all. But this is the power of compounding.
Whoever would have thought when China began its Reform and Opening 40 years ago that we would end up here today? Growth during this time has averaged about 9%, which doesn’t sound too high. But in forty short years… and some people sitting here today weren’t even born forty years ago! We can truly say that heaven and earth have been turned upside down during that time. You must therefore keep faith in the power of compounding. Don’t get anxious; nor is there a need to struggle with others, or compare yourself to them. People who suit each other will find each other. Don’t worry even if you can’t. If you have patience, can take things with tranquillity and do things gradually – you will do even better instead. I made the comparison with golf because golf requires you to keep your emotions still. If you get anxious, you will immediately hit the ball wrong. The results come quickly when your emotions change. If you can keep your heart still, you will do things better and better the more you try.
Live in moderation; train your body; seek mutually beneficial outcomes; use the Golden Rule to arrange your life; don’t beat yourself up; do what you love. These all sound like common knowledge but are hard to live by when you’re young. People are anxious, especially when they’re young. Why is that? Because they’re always comparing themselves to others. Which of your old classmates are doing better or worse? Etc. etc. That’s their lives; what business is it to you? Every person must live their own life. And in fact, our lives are very short. Time feels like it passes slowly when you are young but when you get to my age, it flies past. A year can come and go in the blink of an eye. You must therefore endeavour to live your own life as this is the only way to be happy. In addition, living your own life is the only way to find real progress. Don’t be worried if it takes time. As Mr. Duan Yongping likes to say, “slow and steady wins the race”.