This month, we address the issue of transparency in general, and additionally why we believe operational involvement provides us an edge both in managing our portfolio and understanding the Chinese economic environment.
The latest Chinese CPI, PPM and growth numbers have indicated a general slowdown in activity. Doubts about the credibility of economic information, and concerns that actual data may be worse than reported, have again brought the issue of transparency to the forefront.
Lack of transparency of information related to the economy creates inefficiencies both for investors and consumers.
Investors are rightfully concerned about the accuracy of official economic data in China. This has resulted in reporting that varies from the benign to the extreme – note Jim O’Neill’s recent insights versus Mingxin Pei’s articles in Newsweek. As China’s economy develops, so will its ability to provide robust economic data. Many inaccuracies of reported government data are more likely attributable to structural problems in China’s reporting systems, rather than intentional manipulation. For example, many government agencies still compile data manually. Official company audits are often compiled with the intention of lowering profit and revenue figures to minimize tax liabilities (although one recent newspaper article suggested that the opposite is now done to inflate tax receipts, which we have yet to witness ourselves). Additionally, the data on disposable income collected by the National Bureau of Statistics is done on a voluntary reporting basis, as we highlighted last month. Multiple layers of opportunity exist for mistakes and human error all through the vast exercise of economic data collection, processing and interpretation.
Investors should understand that transparency concerns also directly affect domestic consumer behavior. The lack of information on reliable product safety metrics creates fear and uncertainty, which can be seen particularly clearly in the food and beverage markets. Furthermore, product safety and quality testing is weak and opaque, with state-backed companies owning only 14.5% of the industry but controlling 57% market share. Bain recently released a report on the substantial variations in brand loyalty amongst Chinese consumers and noted, for example, that a typical consumer purchases 6 different brands of facial tissues 14 times a year. However, the same report noted that substantial users of Mead Johnson baby formula were repeat customers 85% of the time. This can be taken as an encouraging sign of emerging brand loyalty, if uneven across different consumer product segments. We also see this as a reminder of the extreme discrepancies in consumer behavior that information asymmetries provoke.
In light of these challenges, how can investors form a better view of China’s macroeconomic environment, and approach the analysis of Chinese investment opportunities? We are reminded of the following exchange between Charlie Munger of Berkshire Hathaway and a shareholder:
Question: “What macro statistics do you regularly monitor or find useful in your attempt to understand the broader economic landscape?”
Answer: “None. I find by staying abreast of our Berkshire subsidiaries and by regularly reading business newspapers and magazines, I am exposed to an enormous amount of material at the micro level. I find that what I see going on there pretty much informs me about what’s happening at the macro level.”
We share a similar view in respect of our operations in China. Many investors pay big money to research firms to read the Chinese economic tea leaves for them, often driven by their concerns over officially reported statistics. We have the fortune, and challenge, of being able to access our portfolio company operating data, and the insights of our team in the field, to keep abreast of the micro and use this in turn to form our macro view. We also find this useful in addressing the challenge, and complaints, regarding inconsistencies in official Chinese economic data.
For next month’s commentary, we will seek to provide certain insights from Portfolio Company operating data that we hope may help you form a better macro understanding of both positives and challenges as the Chinese economy continues to emerge.