Insync delivered a strong positive return for the month outperforming the benchmark and maintaining the consistency of outperformance since inception. Whilst monthly, quarterly, or even yearly numbers are too short as useful success indicators, Insync’s investment strategy has delivered strong investment returns across the vast majority of the investment cycle and time periods. The benefits of investing in the most profitable companies with long runways of growth, fuelled by Megatrend tailwinds is undeniably a useful inclusion to most portfolios.
Value stocks short-lived rally is now rapidly fading. Economic data depicts a general slowdown and the concerns around the risks of a 1970s style inflation breakout appears to be abating. This is a positive backdrop for the Insync portfolio of 28 highly profitable companies across 16 Megatrends. They are delivering consistently strong growth both in revenues and profits irrespective of what the economic cycle is doing. Again, a good argument for portfolio inclusion.
You may have noted that the vast majority of popular global equity funds hold a few crowded China trades such as Tencent and Alibaba. We do not, and this is deliberate. Why is it useful for those tasked with portfolio construction to know this? Namely, for both risk management and fund blending aspects.
Investing in nations with political attributes such as China requires a holistic understanding of the political regime, its regulatory framework and how this has evolved over time.
We spend considerable effort in understanding the history of China particularly during the Mao Zedong era (1949-1976). There are strong parallels emerging in ideology between Xi Jinping and Mao Zedong. This is fundamental to understanding any investment case for holding a Chinese company.
Many investors wrongly assumed that political freedom would follow new economic freedoms in China. That its economic growth would be contingent upon the same foundations as in the West. China instead devised a hybrid economy and has adopted a distinct development model. It has been highly successful so far. One needs to understand how the Chinese Communist Party rules, and how the state works. Its cultural foundations and history generally, and specifically its history with the West requires understanding. Decisions it makes today and into the future within its businesses, and with those companies and nations outside its borders, are shaped accordingly by this.
Tencent – A no-brainer, or was it?
Tencent exemplifies many of the challenges facing investment in China. Yes, it is a wonderful company. It has a strong competitive advantage. It's highly profitable and possesses a long runway of growth with more than one Megatrend propelling it. Worldwide, there is no parallel comparison to Tencent Holdings.
Tencent’s ecosystem spans gaming, ecommerce, music, cloud and artificial intelligence. The US$500 billion tech giant is a collective answer to Facebook, WhatsApp, Spotify, Apple Pay and others.
Management have been outstanding and when listening to the numerous conference calls and analysing the numbers, it was clear that Tencent was being managed in line with some of the other wonderful investments we have in our portfolio. Valuations also looked attractive, thus Tencent ticked all the boxes.
Overall, our research had us very enthused and the China country specific risk factors were also within acceptable parameters. So, we invested in Tencent in 2018. However, we sold the stock 9 months later in 2019. This is highly unusual for us as we typically have a turnover ratio of around only 20%. Our average holding period is 5 years.
What caused this change in view, and one we have maintained ever since, was that the negative risk factors of Chinese investment accelerated sharply soon after without forewarning. They rose well above the positives. This has not changed today except for it to become significantly worse. Investors, however, are often good at self-deception and are adept at blocking out negative developments if they have a developed a positive view (it is called confirmation bias). This is something we, at Insync, are highly vigilant of in our decisions.
Dot one…a bit of history. One of the key ideologies of the Mao Zedong era (1949-1976) was that a revolution against capitalists should be won by violence and mass support. As chief of the Chinese Communist Party, he ushered in extreme state control of the economy.
Recognising the colossal damage his policies inflicted on the people, the leaders that followed over the next 35 years progressively pushed through market reforms. They emphasised economic development based on capitalistic principles. They promoted opening up the country for foreign investment and trade and establishing a thriving market-based economy.
This encouraged an explosion in long-held Chinese entrepreneurship (that was initially suffocated by communism). These entrepreneurs were remarkable visionaries driving innovation and building businesses at a gargantuan scale. This resulted in some of the most advantaged companies globally. They includes the likes of Alibaba and Tencent, both in under just 25 years! Again, acceleration of progress came to the fore.
Western capital eager for growth and noting this acceleration rushed in. Huge excitement within the investment community ensued, rarely with anything but a positive lens applied. As a result, many funds now hold sizeable investment positions in both China overall and specifically in these two companies alone. The bigger the manager the more widespread this feature of their portfolio is by in large.
Then came a new leader with old ideas…
Xi Jinping is the 5th man to rule the People’s Republic of China. The first that was born after the revolution, in 1949. In researching him, even though his style was technocratic, it was progressively becoming clearer to Insync that he was rejecting decades of market economy reforms.
Insync’s considerable time spent researching the Mao era and strong parallels in ideology alerted us to Xi Jinping’s likely style of similar increasing control.
Xi’s influence on the big tech companies became clearer when it was announced in November 2018 that Jack Ma, co-founder of China’s most valuable company, was officially confirmed as a member of the communist party. The lines between business and politics were starting to become increasingly hazy. A concerning trend of disappearing billionaire CEOs from public life began. As President, Xi Jinping led a campaign to ensure the Communist Party plays a leading role across all aspects of society.
Insync is a pragmatic investor. Our political views do not come into the decision-making process. The investment rationale for a buy or sell decision include how companies in China are likely to be regulated and controlled compared to other parts of the world.
China is not an investable proposition today
China’s latest five-year blueprint called for greater regulation of vast parts of the economy. It provided a sweeping framework for the broader crackdown on key industries such as technology, cybersecurity, food, medicine, education, and financial services.
The examples of its impact are many……
The acceleration of political controls and the significant investor losses of increasing control can be clearly observed. The scuppering of the Ant Financial IPO at the last minute, and the investigation into data security at Didi Chuxing, China’s biggest ride-hailing company listed on the NYSE. This was only a month after its listing in June 21. A further example was banning for-profit tutoring in core school subjects. This led to a 70%+ fall in the share price of the leading player, TAL Education. No sector is safe and little warning is given.
When Amazon loses a $10b government contract, they can sue the government. Legal process is applied. But companies and investors can do little against the Chinese government. “What are we supposed to do? We can’t fight the Communist party” — says one Ed-tech executive (Financial Times).
Being a great company with sound tailwinds is not enough. The environment for their investors must also be supportive.
The bottom line for our investors is that after the most recent actions by the Chinese government, China will be off limits to us for at least the next three to five years until it becomes clear how China will interact with foreign investors positively.
Megatrend in focus: Silver Economy
The ageing of the world population has been a well understood trend for over a decade but how does one successfully invest in this trend?
Broad trends are quite often easy to identify but what is much harder to do is identify specific industries and companies that are going to economically benefit from these trends and deliver compound annual returns for shareholders over the long term.
Genomics or heart disease? A key insight from Insync’s work on the ageing population is the projected rate of growth in the 70-75 age bracket. This is the fastest growing five-year age bracket for all people over the age of 55 for the next 15 years and beyond. The proportion of people of this age that develop heart related issues are astronomical.
In 2017, of all deaths for people over the age 70, 43% were caused by cardiovascular disease. This is 2.6x the number of the next largest cause of death which is cancer. A major issue for this age cohort is that many patients are unable to undergo open heart surgery as the risks are too high for many.
The heart is a highly focused organ. It has just one job to do, and it does it supremely well. It beats. Slightly more than once every second; that’s 100,000 times a day and as many as three and a half billion times in a lifetime. It rhythmically pulses to push blood through your body and recycle it. And these aren't gentle thrusts, they are jolts powerful enough to send blood spurting up to three meters if the aorta is severed.
Advances in medical procedures for the heart has been one of the success stories of modern medicine. The death rate from heart disease has fallen from almost 600 per 100,000 in 1950 to only 168 per 100,000 today. As recently as 2000, it was 257.6 per 100,000. Yet it is still the leading cause of death. In the United States for example, more than 80 million people suffer from cardiovascular disease.
The cost to the US alone of treating heart disease has been put as high as US$300 billion a year. If left unchecked cardiovascular disease costs are projected to exceed US$1 trillion by 2035 according to the American Heart Association.
The combination of a rapidly ageing population and the escalating burden on healthcare systems allow companies that are treating heart disease to be significant economic beneficiaries. A market that is already very large today will become significantly larger and at a faster rate in the decades to come.
In comparison to surgical procedures, TAVR has a higher survival rate (99%), lower rate of stroke, bleeding, and other complications.
General anaesthesia is not necessary in the procedure and most patients leave after just an overnight stay. This provides a significant cost saving as hospital surgery, anaesthesia and costs of stay are significant burdens to healthcare systems.
It takes time for the right company to appear.
Like many new and exciting technologies, it has taken time. Over 15 years in fact, for the market to start adopting TAVR to a level where the companies pioneering the technology become highly profitable and industry leaders.
Insync’s record of successfully investing in Megatrends matches a combination of high and accelerating adoption rates, with a leading player beginning to dominate in one of its primary business sectors. This results in businesses which are both highly profitable and can grow sustainably at high levels over extended periods of time.
Insync’s investment focus is on both Megatrends and profitability
Many healthcare and innovation investors have focused on genomics and gene editing. After all, it's emerging and exciting- the possibilities are immense.
Insync however considers this technology to still be in the ‘hype phase’ of its investment cycle. The pathway to identify future profitable winners is still highly uncertain and that adds significant risks to investors. Investing in the innovative treatment of the heart is a more assured way to grow your wealth (and health).
Not all innovation however leads to profitable growth in a company. Having the right methods to then assess which company, if any, can harvest a Megatrend and possesses the right financial and market position is equally as important. Simply holding a ‘sector bet’ across many stocks (e.g., with a passive ETF) in a sector such as healthcare presents additional and heightened risks, that Insync investors do not have to bear.