In the US market, the price difference between the two stocks in the next two quarters, the three-day fluctuations between 7 and 6, there are some small spikes, the volatility is only 0.25, this market is very difficult to make money, and its liquidity is not good; and in the Chinese market, the downward range of volatility is at least 15 points or so, and our volatility is 50 times that of the US market.
Overvaluation and asset depreciation create an unstable market. The United States suffered a financial crisis in 2008 due to liquidity shortages. China, at this point, is also experiencing volatility in major markets, as hot money is flowing and you as an investor are not holding anything firmly in your hands.
Strategic coverage should be laid out. Traditionally, the three-axis strategy is to choose stocks, options, and leverage. Overlapping the three is the strategy of many private equity funds. Borrowing from my previous experience in Texas hold'em, it is necessary to separate the strategies, stocks, commodities, options, fixed income.
Investing is about two goals, one is the return and the other is the risk. The return is very difficult to determine, but the risk can be a better quantity. The prediction of risk is generally not so great, since the risk is better quantified, we start with the risk, say I require the volatility rate can not exceed 8%, we do a simple optimization, what will happen?
It all started with the Wall Street Crash, a book about some of my experiences on Wall Street from 2005 to 2011; just before the financial crisis in the US, when I had a lot of thinking and finally wrote it. The book is about three things. The first is some personal professional experience, which can be used as a reference for friends who are just starting their careers. The second is about some personal stories before and after some US financial crashes, mainly some of my thoughts on the logic of US financial markets.
I've been back in China for over a year now, and I've started a hedge fund management company in Shanghai with friends called Equity Asset Management Limited.
Today's talk is mainly about stories, hoping to make things easier. I will mainly talk about three aspects: first, why I think China's financial markets are ushering in an era of great development. Second, share my understanding of the logic and challenges of the Chinese market. Lastly, my experience of entrepreneurship after returning home more than a year ago.
I have been working in the US financial market for many years, and I feel it is becoming more and more difficult to do, and investing opportunities are becoming less and less, especially in the field of hedge funds. What is a hedge fund? I feel that the Chinese financial market has entered a rapid development path, especially since the registration of private funds was opened in 2014.
There's a little story here, and two of my colleagues asked me, "You're very good at what you're talking about, but what's your strategy for making money?" "I'm especially responsible for that", I said, "I don't have a strategy because I haven't done it in the Chinese market". But two things are important, strategy research is a gold-digging process, and I'm more familiar with it, and I believe China and the United States should be pretty much the same, and you can dig in the right place with a stick.
At the end of 2014, China had just begun a major financial reform and launched a lot of new products, and I felt this was an opportunity. After I said these two things, I was still a little faint, not quite sure how many opportunities there were. Once I was on a plane from Shanghai to Shenzhen, and I asked the flight attendant for a report on the stock market, and I saw the headline of the report on the stock market futures.
I found that first of all, the Chinese stock futures are designed to mimic the US. The US is the S&P 500's ES futures, and our country is the Shenzhen 300's stock futures, and the two contracts are very similar. From a point of view, the two are roughly the same. The S&P 500 is 2,000 points, and the Shenzhen 300 is almost 3,000 points.
I'm very familiar with the US market, so I pulled some data. The US market is getting more and more efficient, and it's getting harder and harder to make money. At that time, there was a set of data that was the price difference between the two quarters of two stock futures that were adjacent. The three-day fluctuations were between 7 and 6, with some small spikes and only 0.25. The market was very difficult to make money, and its liquidity was not good.
The history of hedge funds in the US
In the United States, I think there are three types of hedge funds, the first is the so-called value hedge fund hedge fund hedge fund hedge fund hedge fund hedge fund hedge fund hedge fund hedge fund hedge fund hedge fund hedge fund hedge fund hedge fund hedge fund hedge fund hedge fund hedge fund hedge fund hedge fund hedge fund hedge fund hedge fund hedge fund hedge fund hedge fund hedge fund hedge fund hedge fund.
The second type of hedge fund is the hedge fund that is looking for opportunities, the market for the wrong pricing. They trade with a high frequency, represented by Soros. He makes short-term trades in both sterling and Thai. There is also a very famous Renaissance company, which is probably the most famous quantitative fund.
The third type is the "Psychoanalytic school of thought". Do you know what an effective market theory is? It probably means that the market contains all the information, and you and the market have no chance.
Let's take a quick look at the history of the development of American hedge funds and see who is right and who is wrong.
In historical chronology, the first period was after World War II, 1945-1960, when the US exchange rate was very stable, the Bretton Woods system stipulated that an ounce of gold was exchanged for $ 35, other currencies and the dollar were pegged, and the exchange rate was also relatively stable. In this era, simple holding of shares was the best way. Buffett was the first barrel of gold in this era.
There was a similar era in China, after joining the WTO in 2001 until the financial crisis in 2007. I did not experience that era personally, but I have seen some material. The economy was growing rapidly at that time, the population was relatively young, and there was a huge demographic dividend.
By the 1970s, there was a big change. Because the United States was involved in the Vietnam War in the late 1960s, there was also some instability at home, and the economy was getting worse. Nixon made a decision, the dollar and gold broke apart, and the Bretton Woods system was broken. If we crossed that era, we should have made a lot of money.
The 1980s were a very interesting era, when there was a very rambunctious Fed chairman, who kept inflation in check no matter what the economy did. At the beginning of the 1980s, U.S. interest rates were very high, and short-term rates were about 20 percent. From that era to now, U.S. interest rates have been in a long-term decline, with the 30-year national debt rate falling from 15 percent to just over 2 percent. There was also a very important policy adjustment in the 1980s, when the West had a period of a shift to the left in the 1960s and 1970s, when the country had a relatively more diversified economy. By the 1980s, President Reagan and Mrs. Thatcher had a new economic policy.
It was also a very important time for hedge funds, because people used to make money by guessing, doing more or doing nothing. Beginning in the late 1980s, hedge funds emerged. I wrote in my book that there was a team at the time at the Solomon Corporation, which later became LTPM. Morgan Stanley had a mathematician who started a group called PDT, which existed until two years ago, and from this group came D.E. Shaw and many very famous quantitative hedge funds.
Why is this? I think China has some of the same situations. Many hedging methods have emerged, including the bond market, which has begun to make some innovative moves, the recent acceleration of asset securitization, and the emergence of many new financial products.
The 1990s was a very interesting era, I was in the mid-90s in the United States. The first was the technological innovation, mainly related to computers, and Microsoft was the one that developed. The second point is somewhat similar to China, which was the baby boom in the United States, when the dividend began to be released. The US population was also a monkey, middle-aged, younger. The peak of American baby birth was four or five years after the war, and lasted until the 1970s. If you count their age, in the 1990s, it was 20-40 years old.
Because of the popularity of bull markets, mutual funds, and publicly traded funds, the most famous are the managers of the Magellan Fund. By the end of the 1990s, the Asian financial crisis and the Russian financial crisis also occurred, which also had a very big impact on the hedge gene, including the famous long-term capital (LTCM) collapse.
There is also a half-chapter in my book devoted to the process and logic of long-term capital before and after; why this? because that was the first time a hedge fund failed; and then there were similar cases, including last year's in China; different in detail, but very similar in the macro; and if leverage is used too much and there is a liquidity crisis, it is gone.
In 2000-2006, the beginning of the bursting of the technology stock bubble, when the emerging markets began to rise, represented by China. Because China joined the WTO in 2001, and after the great development of China, some of the countries that provided raw materials also followed the development, the emerging markets began to rise. In the United States, in recent years, because of the investment in the continuous development of business, there have been great advances in the financing of financial instruments, hedge fund services.
The biggest hedge fund that the Chinese have now is probably over $10 billion, probably from JP Morgan in 2004 or 2005. I worked in investment banking in 2005 or 2006. The book also says that there was a very strange feeling that it was hard to make money. The bonds were still relatively low and the credit gap was very narrow. What do you do now?
2007-2009 was a financial disaster. I think maybe everyone has this very important time in their life to see the world, because I've really experienced all sorts of things firsthand. It's usually tens of millions of dollars to make money, and when the crisis comes, there are tens of millions of dollars to withdraw. The various stories of Wall Street are a very good experience, and the lessons are very worth learning.
In retrospect, I don't think the Fed had any of that either, they didn't have enough experience. If they were the Fed today, Lehman wouldn't have gone bankrupt, they would have taken more decisive action sooner. But nobody saw it then, and it ended up very badly. In late 2008 and early 2009, the U.S. market was also very strange, asset prices were in a very crazy place. Looking back, having money at that time was a very good thing, building a warehouse at that time, would be a very good example for a few years.
The next is 2010 to now. I think in this era, the market is somewhat back to 2005 or 2006 because it was a zero interest rate era. At the beginning, people were still relatively happy because zero interest rates, stocks and bonds started to go up, and they could make money. After asset prices rose, asset yields gradually declined, especially in the fixed income sector.
Over the past few years, the industry has been increasingly competitive, and we've heard that U.S. hedge funds performed very poorly last year, and they've done very poorly for a while this year. I looked at the U.S. hedge fund index, and the first four months of the year were all negative, with only one of them being a positive 3. We saw a few more common ones, and the median yield of the market-neutral quantitative strategy funds adopted was 1.33%. The median yield of fixed-yield hedge funds was 0.32%, and it was very poor. This is not the first year, because I have friends who work locally, and they have been doing this for several years.
It's another interesting topic. We started with the story of Zhao, Zhao, and Zhao's School of Mines. After 40 years, it seems like Zhao's School of Mines makes sense, because the US market is actually in the era of the quasi-effective market.
Americans used to like to buy mutual funds, now they are not popular, the most popular in the United States are index products, such as ETFs. The logic is simple, if I don't make money, I can control the risk, I can not let myself rush all day for this stock. I myself, including myself, I have bought many ETFs in the United States and have not moved it for many years, I think it is a very good way to invest. If you say that everyone has a need to invest and does not want to spend a lot of effort to study this, I suggest that you can invest in indices, get rich.
China's second financial boom
I think we're comparing China, where there are places like the US in the 1980s, there are places like the US in the 1990s, and there are places like the US in the last few decades.
The first is the size of China's economy and its position in international trade, which is already close to the United States.
Secondly, the internationalization of the yuan is a trend. As the yuan internationalizes and becomes one of the international reserve currencies, Chinese money goes out and foreign money comes in, which generates a lot of demand for capital.
Thirdly, the money is continuing to increase. We used to have a friend, an economist, and he said that one point is still very reasonable, China is not doing a lot of business very well now because of fewer and fewer customers, but if it is the asset management industry, in fact your customers can actually be your customers. The more money you have, the more you need to be managed, the more customers you have. But our country's M2 is growing very fast, so the asset management industry has more and more customers.
Fourth, policy orientation. This was my judgement in 2014 and may have changed slightly now, but I think the general direction is still the same. I think we should get out of the middle-income trap because the government wants to promote the transformation of the Chinese economy. The trick here is not much, but financial reform should be one direction. Increasing the proportion of direct financing to reduce the cost of capital in the real economy and also promote the rational allocation of social resources.
Fifth, the Chinese are very good at betting. Stock futures used to be a very high-end thing, only qualified investors, you need to have 500,000 in a brokerage, and you have to trade 10 commodity futures before you can trade. But we created a stock market futures auction machine, he broke down the stock futures, no matter what you do, you can make a cup of tea, you can bet big, you can bet small.
I think we've had this era in the US, where retailers are more and hedge funds are relatively easier to make money. In recent years, things have changed, for example, 70% of the stock market is high-frequency, and the remaining 30% is filled with people like D.E. Shaw, which I think is a more difficult market.
I've been back for over a year, and I've also been in contact with some people in the private sector, and there are a lot of good people, and they have very good ideas. But overall, the level of formalization and theoretical level is probably the same as it was in the United States 20 years ago. Here's an example, and we were doing research that year, and I got in touch with a local Alpha CEO. I think he was relatively cautious and didn't want to say much, but he was happy to talk, and he also told me a little bit.
This got me thinking, what am I doing trying to be an Alpha? I have a little bit of an understanding. China has over 2000 stocks, you can buy a few small stocks and then hedge against them with 300 futures, which is the equivalent of buying some smaller average stocks and hedge against some big stocks. China thinks it's Alpha, but overseas it's a risk indicator called the Size Factor.
In 2012-2014, small stocks came out of a huge bull market, which we now know as the "super bull market", and we can see that Size Factor made 15% in two years. In such a market, you add a little leverage over 30%, 40%, 50% is possible. I think this can't be called Alpha, at least it won't be called Alpha abroad.
I felt very bright and confident when I came back to do it. Then I concluded what kind of risks are there, two of which are the macroeconomic and political situation, will there be any changes? Unfortunately, there have been a lot of things in this area in the last year, including the stock market crash in China.
After returning, I was also confused for a long time, and I found the logic of the Chinese market difficult to understand. I arrived in Shanghai on March 17th, the stock market was in flux for nine days, and there were all sorts of strange things, including startup boards, templates, etc. A six-billion-yuan-sized classified fund that hadn't made a single transaction yet earned a 50% premium, and I found it hard to understand. From 5,000 bull markets, there were three stock crashes in a row.
There are also listed companies, and I have a lot of opinions about them, how can a listed company just drop out of the list? A shares can be hundreds of companies at any time. There are 1,000 at the time of the stock crash, including the TV network, even in the company.
This is still logical. I conclude that a larger logic is that the overvalued VS assets are empty. Overvalued means expensive, and the overvalued assets mean that investors have nothing to buy. Why this phenomenon?
The second reason is that secondary market indices are scarce from a supply point of view. Why? Because China implements an approval system, foreign companies are registered, you can list in the United States, as long as you can meet its requirements, your shares can be sold out. And China's IPO is approved, and there are now more than 700 in the Securities and Exchange Commission queue.
The two combined to create an unstable market. The United States suffered a liquidity slump in 2008 that led to a financial crash. China, at this point in time, also suffered from volatility in major markets, as hot money was flowing and you as an investor were not sure what to hold in your hand.
What's the logic of the Chinese market? Chinese VCs, PEs, M&A funds are all very hot, and their basic logic is to dump assets into the A-share secondary market. That's their basic investment logic. Because the A-share secondary market has several price differentials. Say I'm a public company, I get a billion-dollar asset from somewhere else, I put it in my company, it's worth $5 billion, and I'm net worth $4 billion.
Of course, there are also companies in China that have a conscience, like Liu Bei, whose dividend to shareholders has already exceeded the value of the shares sold in that year, and we need a company like Liu Bei. But most companies are trying to sell their shares, such as mergers and acquisitions, mergers and restructurings. What if the shares can't be sold? I can transfer debt, or they end up becoming shares anyway.
There is also the fact that performance is better than telling stories, industry is better than selling stocks. Recently, there is a popular passage that says that the United States is going to make a new energy car, OTV is going to make a PPT, look ahead. The Americans are going to send a rocket, OTV is also going to do a PPT, look ahead.
As an investor, I'm very passive and always feel like I'm getting nothing.
Bond yields are low and credit risk is high. Credit incidents have been frequent in recent years because of the credit incidents of some state-owned enterprises, such as ZTE. Real estate, in my personal opinion, is not very good either. Because China's demographics are changing.
Putting the performance of the Shenzhen 300 and the balance of the financing bonds together, it becomes a capital-driven gambling market. The Shenzhen 300 started with a bull market in July 2014, which rose from 2000 to 5000 points, then fell back to 3000 points in the national bailout market. In September-December 2015, there was a small bull market, then fell again.
Secondary market stocks are very expensive now. In the long run, I feel that there is no investment value. It was possible to hedge, but after the stock crash, stock futures and bonds were restricted again. In fact, in July and August last year, because the fund was not officially operating at that time, trading was relatively small, there was no feeling of a stock crash.
The way to solve this problem, in the long run, should be registration to bring the market back to its source, to increase the stock supply. But where is the problem? The timing of the launch is difficult, the bull market can not launch, because once the bubble is launched, it will break. The bear market can not launch, because the people would be angry, you can not launch another registration.
3 How hedge funds can adapt to the Chinese market
Since we decided to do this, we always had a few tricks, and then I'll talk about my entrepreneurial experience.
The market is constantly changing, and in the changing market, it is necessary to find new ways. For example, in 2009, after the crisis, the United States had some new jurisdictions, new business models. What should the Chinese market do? First of all, a relatively basic question, what should we do as a holding company. This reminds me of a small experience at Goldman Sachs.
In this regard, we should also serve our customers well. I think that the awareness of the domestic brokerage is not very strong, and everyone, like the policymakers, sends a bullet. I think that whoever can do good customer service should be big and do it in the Chinese market, which is what we want to do.
What exactly do our clients need? First of all, my partner Liu Yijian once said that China has a lot of talent, a lot of money, but there is no clear definition of risk and return.
Let's make a simple comparison between the investment methods. Firstly, it is the balance sheet, 3%-4% is a hedge fund, there is no risk, but the return is low. The average return on the stock market in the long term is about 7%-10%, but the volatility is relatively high.
How to solve this problem? Hedge funds. Traditional hedge funds abroad can achieve a Sharpe ratio of 1:1, with a risk-return ratio of approximately. The return striving is in the double digits, the risk is slightly lower than the stock market, which has a certain value. We want to be a multi-strategy asset management platform.
The first step is to manage the risk, to fully understand the risk. The risk is not just simple trading risk, the market risk is the first, but also credit risk, liquidity risk, IT technology risk and legal compliance risk, etc. If leverage is used, liquidity risk is taken into account. We have electronic trading platforms, afraid of problems such as the thumbs up.
The second is that the strategy coverage should be spread out. Traditionally, the three-axis strategy is to choose stocks, options, leverage. The three-axis strategy is the strategy of many private equity funds. Now the stock market is more difficult to make money, so it is also necessary to increase, borrowing from my previous experience in Texas poker, to separate the strategy. When we were young, the peak could be six to eight discounts.
The third is to use the power of asset allocation. After the Chinese gold stock limit in September 2015, it is more difficult to make money. What should we do?
We have some basic tricks. Firstly, we have compiled some indices internally, which are cheaper than buying stocks, a little cheaper than buying ETFs. From last September onwards, it is still possible to make money and gain 10% or more. But the problem is that the volatility is very high, from up to down with a 30% pullback.
The second is bonds. This curve looks good, it's good. But the yield is 3%, it's still a bull market for bonds, so that's the problem with bonds, that is, it's not risky, but it's not high yield.
Finally, commodities, which are our internal commodity commodity index. Commodities will face a long-term bear market from September last year to now. If you start painting from 2012, there will be a bear market for more than two years, what do you do with that? If we summarize our quantification method, we can calculate the annualized rate of return, the volatility rate and the Sharpe ratio.
When calculating the Sharpe ratio, none of these three are ideal, the risk taker is not making enough money, the risk taker is making too much money, what? We just talked about, say we limit our volatility to 8%, which is a mathematical indicator, which can be done. Investing is two big goals, one is the return, the other is the risk.
The green line is stocks, the more even blue line is bonds. First up and then up are commodities, and the ratio is 40 percent bonds, 40 percent commodities, 20 percent stocks. You get a good yield curve, but much less volatility.
I've talked about the development of financial theory before, and in fact, overseas, since the fifties and sixties, much of the development of the financial sector has been in risk control. There are relatively mature theories for how to manage risk, how to manage portfolios. This is an example of the simplest configuration. If we add the asset types we can choose, add strategies, we use more complex methods, we get better results.
Fourth, quantitative means to process information, technical means to complete transactions. What is the nature of quantitative funds? I think investing is first of all about information processing. I'm going to make some decisions based on information, which can be processed by computers with a lot of data, we look for some historical laws to help you make some decisions.
Finally, it may also be because of my real-world experience in the United States, which you can hardly summarize. I spent my first year at Shandong University in the military academy, but I'm still very sensitive, the army has to be formalized, refined, so that it can have combat power, and we can't be very loose.
I personally think that the next 5-10 years will be the golden age of the hedge fund industry or the development of the hedge fund industry, a great era of hedge finance. Why do I say that? When I was younger, I heard a saying that this is a lot of people's luck, two, three, four, five, five. I used to think that this was a feudal superstition, and I can have it today because I studied well. But now we think this is still very reasonable, what is the so-called fate, wind, wind?
So I think the next 5-10 years will be the golden age of the asset management industry, the industry that stands on the brink. It's a bit like the internet a decade or so ago, it's a very right industry.
In addition, many readers have asked me if I want to write another one after writing the Wall Street Chaos, which has been going on for several years. Some people have used the name Chaos Financial Street Chaos or Chaos Land House Chaos, I think that the United States can write Chaos World, China can not be called Chaos World, or the Great Age Chaos, maybe later. I have a plan, I want to open a WeChat public address, I want to write half of what I wrote before, including some articles about investment.
Translated from private workshop