A Quant in China’s Casino

Published Jul 30, 2021, 6:06 PM

The attention of global investors returned to China this week as a crackdown on for-profit education companies triggered a massive selloff in the nation’s equity market. Jason Hsu, founder and chief investment officer of Rayliant Global Advisors, discusses how investors should navigate through the nation’s regulatory risks, and how the dominance of retail traders gives China’s market a “casino feel.”  

Mentioned in this podcast:

China Bans For-Profit School Tutoring in Sweeping Overhaul

We Don’t Need No (For Profit) Education. ESG, China-Style

Hello, and welcome to What Goes Up, a weekly markets podcast. My name is Mike Reagan, and I'm a senior editor at Bloomberg. This week on the show, while the attention of global investors has once again returned to China, but this time it wasn't because of the trade tensions with the US. Rather, it was China's own domestic crackdown on the for profit education industry, spooking investors to the tune of more than ten percent drop in the MSc I China Index in just two days. It was so shocking that Golden Sacks strategists actually came out with a note saying clients were asking them if China had become uninvestable? Well has it. We'll get into it with a chief investment officer who's currently in China, But first Charlie Pellett talls through this week's mystery co hosted is This week's mystery co host is Ye She. He is a markets reporter of Bloomberg and was a go chess champion as a kid in his hometown of woo Sheet, China. Since moving to the U S sixteen years ago, he's become a Seinfeld fanatic and still listens to reruns on his iPhone every night to help him understand close talkers like Reagan. He I to him as Seinfeld fanatic. As you know, I hopefully in the if Bloomberger Seinfeld, I'm thinking I'm probably the Kramer character. I don't I don't know, hopefully not the Newman character. What do you think? Yeah, my favorite is Geosh Castenda, Absolutely absolutely, I think he's everyone's favorite. And you also have now have been intrigued with go Chess. I'm gonna you're gonna have to teach me how to play that sometime, right. It's uh, it's like one of the Asian most ancient chess game, very popularly in China, South Korea and Japan. And I just taught myself at the age of the probably five six, and just uh really obsessed that he was playing it. But I want the the champion in the city when I was in middle school. Um, but I stopped playing in high school because I'm so busy. It was a study. So I'm sympathetic about the crackdown of the cram schools. I'm sure we all talk about on the show. That's a That's a good segue into our guest here and what's going on in China the gram schools UM and let's bring in our guest. He's uh really had a quite a resume in the financial industry. In the investing industry, it's one of the co founders of Research Affiliates, and more recently he is the founder and chief investment officer of Raylean Global Advisors. His name is Jason Sue. Jason, Welcome to the show. Glad to be here at Jason, I wanted to get into that idea about the the for profit educ asian industry in China. Now, luckily I know a little bit about this. I edity every day, so I've I'm able to read his insights on China, so so I know a little bit. But I think for a lot of Americans this seems like a strange thing for a market sell off, a crackdown on the education industry. But walk us through, um, you know, basically, what problem is China trying to solve here with this crackdown on for profit education and why such a dramatic impact on the market in China. Absolutely so this is a little difficult for I think Westerners understand because CRAM School, the for profit educational sector is something very foreign to Westerners, but it's a part of the Asian culture, not just Chinese, but really I think it is just a part of you know, the Korean, the Japanese and the Chinese culture. Essentially, CRAM schools offer you additional after school tutoring, and it often occurs in the form of sort of UH regurgitation UH memorization of a vast test bank of questions are likely to be on the next national entrance exam. Right in in Asia, gain gaining emissions into the top high schools and eventually from their top universities requires one scoring at the top of the list a national entrance exam. UH. So most students spend all of their days essentially preparing for that big exam. And the easiest way to to get a high score is not by doing well in school, not by just you know, by by understanding the actual knowledge UH. The easiest way to gain emissions is to practice test exams over and over and over and over again. And if you pay to go to one of the more UH premium UH tutoring programs, you just have access to the latest test banks. You have access to experts who may have UH greater ability to predict what's going to be on the exams. Uh and and thereby gaining enormous advantage. And so in Asia, it's a very expensive exercise to to go through these cram schools. They're they're costly, they're expensive, but it's also in terms of the hours that children commit to additional memorization and studying. I think this has become such a social problem. If you cite the the number one reason for for teens committing suicide, it's because of the just the unbearable hours that that they have to commit to this. And also for a lot of parents, it's it's it's very expensive and it feels very unfair because, uh, the premium programs that give you the highest chance of scoring high on the Nastal exams are quite expensive. So it's it's broadly understood and viewed as a social program problem. Uh. You know, Taiwan has tried to fix that. I think Japan has tried to fix that. Again. You know, as I mentioned, the the high suicide rate is really a problem, and I guess China has come down with its own way to fix the problem by essentially making these CRAM schools nonprofit and hopefully uh taking them out of the equation and never a pretty big chunk of equity involved in this. I guess you know, these companies have grown so large because of all those well absolutely, I mean the for profit cram schools are incredibly profitable. Their massive I mean, there was a point in time in China that the for profit educational sector is viewed as the most important consumption demand. Right like people are with would stop paying rents, they would stop eating just so they could keep paying for cram schools for their kids. And so you know, it was viewed by investors as one of the you know, probably safest industry to investent. The joking Chinese people asking why cracked um education companies are the cramp schools will bring down the whole market. Um. The joke was, I think about this way. If there's ten birds on a tree, you shoot down one, how many birds are left on the tree. I thought this is a good analogy to explain the fear. People are worried about who's the next target from for as you mentioned that Jason that for a lot of like foreign observers or investors, they don't quite understand Chinese policies. It seems quite random ad hoc in terms of policies and regulation changes. If we think about it, it it started with end Group in November when China put down their listing at the last minute. Then we start to have um government targeting Ali Baba Tennis and all these big internet companies for their acknowledged behavior. Then we have the d d UM the government banned their apps soon after the I p O in the US. Now we now we have the education companies. Is any coherent logic of all these government actions? Is any ultimate goal China is trying to achieve? Absolutely. I think the best analogy uh and hopefully one I think the the West will be more sympathetic to is you know the Chinese regulators. Uh. They see themselves as you know, part of the global E S G trend right. Um. You know, part of it is saying that, look, the free market doesn't solve all problems, so you can't just leave problems, especially social once the free market very much, you know, in line with the E S G. Uh, I think philosophy, which is you need regulators, you need socially minded individuals investors, uh to to sort of come and undo some of the excessis you know, some of the negative externalities of free market competition. And so I think the Chinese regulators very much I've been looking at, you know, what are the problems that perhaps we know profit maximization has created that they they think needs fixing, that that society can't tolerate anymore. So if you take the the educational sector, I think, as I mentioned, you know, that's that's been a social problem that a lot of Asian regulators, a lot of Asian economies have been trying to to fix. But if you even look back further right in in the recent month, as you mentioned, where it is um sort of cracking down on some of the big consumer tech where the monopoly power has made both war conditions very very bad for labors and also made it uncompetitive for smaller business to get in. For example, you know Maton, Uh, They're share price also took a beating when when the regulator announced that it is not acceptable for them to treat all of their employees as contractors and not pay a century social security for them. Um. So you know that's very much uh, something that that that's been talked about in the US, you know, with uber would lift where essence you regulars. As you know, the businesses are being unfair and not paying their fair share for uh you know what, other you know, for profit businesses have always paid. We just pay into the Social Security for for employees instead of treating them as contractors. So if you look at um these issues and understand them and clearly just they're gonna be idiosyncratic to each economy and markets, you'll start to be able to predict at least the Chinese regulators behaviors when it comes to what are the important E s G. Issues that they're grappling with and they're likely to act on, you know, Uh, Jason, It's one of those times I wish this podcast was on video. I just want to set the scene for listeners here. Jason is appearing to us from what looks like the Starship Enterprise from from from Star Check. Absolutely my favorite zoom background I've seen in a lot of these. I keep expecting to get a call from Scotty, you know, saying we we ain't got no power captain or something. But Jason wins the best zoon background of in what goes up History. I'm gonna say say it here right now, but Jason I in that intro, I said, I mentioned that note from Goldman that was out this week saying, you know, their clients are calling them up saying is UH is China uninvestable right now? And I know you're managing a active ETF with charity stock. So I'm assuming your answer is so, I hope not at least you know. But but but given this sort of you know, regulatory risk that we're talking about, how do you how would you answer that question? You know, you sort of hinted at the idea of trying to put your head in the mind of Chinese regulators and get ahead of what might come next. But what is sort of a good industry that in China is a beneficial to society that you don't have to worry about the government sort of turning off overnight like we saw in the education industry. Well, I would say now that the government has sat down and had a good talking to with the big financial I guess, with the big finn tax and the consumer tax uh, and then warned them about wielding monopoly power. UH. I think you know, for firms that truly have innovated and that have brought products and services that have made things better and easier, Uh, certainly benefited the consumers created large, you know, large number of jobs. You know. I think governments are are generally globally and and then certainly in China supportive of businesses and industries like that. So I would say, you know, broadly, you know, most of the firms that have sold off are probably good buying opportunities today, just pay attention to those are likely to be in a cross here of the regulators. Right so, uh, you know, firms are uh you know, continue to wheel monopoly powers and uh and and don't seem to sort of get the memo with regard to um, you know, the government's sort of displeasure with with monopoly hours and and anti competitive behaviors. Uh. And certainly, And I would say industries that traditionally in the West that we're more concerned about, you know, the liquor the tobacco, those are all likely to be issues as industries that are big polluters, that are anti green and being given that carbon neutral is now big initiative for for China. So those industries I think that that traditionally are more of the negative or low e s g uh firms and industries I think those sort of big risks in China. Uh and uh. And again you know this is partly because you know, Chinese regulators and the Chinese societies no different to the Western societies. As they become wealthier and can afford it, Uh, they do demand some of the very same sort of E s G issues to be taken care of as as that we in the West do. So there's this sort of a perception um from the investors, especially after the recent events, that it looks like the Chinese has become anti capital now they are moving backwards. At least there's there's a perception there. I guess that's why Goldman had feeded so many calls from their clients, whether Chinese investment or not. It looks like there should be a China discount because people don't understand the rule anymore. People don't understand the boundaries anymore. Um and Uh. I saw there article from Steven Roach, his long term China boar. He he said he's been optism optimistic about China for the last twenty five years. Now he started doubt whether this is a this is a moment he should have a have a second sought, So, do you think that China is doing the right thing. Well, uh, I think you know, execution can always be better. I think, you know, lot more pre communication, being a lot more clear about what the regulators I want to accomplish, being much more I would say transparent with regard to the sort of E s G agenda especially, I would say, you know, carbon neutrality will be a good one. China's been signaling that, signaling its path or green. Uh. And and I think that's helped out the market a lot in terms of understanding where to direct capital, what to expect. If if China sort of shares that same kind of transparency with regard to perhaps more of the negative E S G issues, that would help the market out a bit as well. And certainly I think the investors got to do the other half right because actually it's it's been in the number of policy speeches given by presidents She going all the way back to late eighteen with regard to his concern about the inequity in the educational feel and and really the pain created by the crams schools on on the children's and their parents. So I think investors also have to to you know, listen a bit more tentatively to to sort of some of these policy pre signaling, but I would say yes, in terms of execution, it can always be be better understanding how markets can lose confidence um from from even the slightest I think surprises coming from regulators, especially when it comes to China and especially in this current environment. So yes, you know, much can be improved upon. But I would say that the work goes on both sides, by both the regulators in China but also investors looking to invest in China, because we've got to recognize it is a more foreign market. Our access to information is a little bit more challenged versus our access to information when dealing with say us UH than the ICY, and so investors really do have to work a little harder as well. Right, It's not a responsible approach for for managers and investors to to simply just blame Chinese policymakers in this case. You know, Jason, you have such a strong background and sort of the the academic quantitative approach to to investing, you know, at research affiliates and presumably now at this firm, and at risk of repeating a joke I think I've already made on a previous episode of the podcast, but you know, to me, it's like being a quant in the market is is sort of taking the you know, being like in the college classroom approach to markets where the retail trader has taken over and it's it's now more like a market that's a fraternity party rather than a classroom setting, you know. And I know in China it has that reputation for being a such a retail driven market. I've seen stats something like correct me if I'm wrong, something like volume is China is retail driven and and very much a sort of a gambler's ethos rather than a you know, buy and hold investors approach to the market. So I want to ask you a two part question about that, and feel lucky sometimes I asked twelve part questions, So two parts let you off easy. But uh so, how is a quant approach China given that type of of dominance in the market among the retail set. And secondly, um, you know, are there lessons to be learned from analyzing that cohort of the Chinese market for what we're now seeing in the US where this growing dominance of of retail investors and kind of their unpredictability and they're sort of you know, investing on whims and message boards. I'm guessing momentum probably is a factor that that translates regardless. But I'm just curious, you know, as as a quant how do you how do you approach a retail driven market like China? And you know, are there lessons to apply to the US market as the retail trader sort of takes over. Absolutely, So, first of all, you're absolutely right that China is a retail dominatant market and because of that, there is a very much casino feel to it and rader than a loan term investment, retirement um investment based um feel too to that market. The result of which is, in a short run, prices can feel random, right, Prices don't seem to rationally respond to either news or sort of changes and developments in the fundamentals of companies. Now that's of course not a China specific issue. Any market that's heavily retail, for example, in the US has gone from three percent retail to now closer to thirty percent retail with you know robin Hood free trading and and you know Wall Street bet dot com, Uh, you know type type of activities and uh, and you know in China, it's just you know, three times the the the the magnitude right because they they're they're closer to or thirty. So I think as an investor in the short run, what will help you be successful is actually focusing more on what drive sentiment, right, so be it the news cycle orright, be it what is capt doing the attention of media, of major influencers on on blogs and and podcasts. Those are probably likely to give you more of an edge trading in that market. So in some ways, UH think of you know, short term signals, betting out short term momentum, short term mean reversion, looking at almost you know, technical pattern UH type analysis are going to give you an edge more so than looking at long term fundamentals understanding industries and firms. Uh. And in fact, you know, the most successful investors in China today, you know, are not the stock pickers who understand casual discounting, not the quantz who understand sort of these long term factors I predict earnings growth, but really people who employ technical analysis on a on a daily basis, you know, the you know, I would say more of the high frequency market maker type of investors and strategies uh and yeah, So in that type of market, uh, or you simply have to bring into play a lot more of the non fundamental, more of the sentiment based analysis to um to really have short term success. But I think in the long run markets always converge and come back to fundamental and China is no difference. It just means you have to put up with more of the short term noises. I just I'm I want to let you talk to your book a little bit here and uh to talk to me about the Railian quantamount old China e t F rayqu was the ticket right? And tell me race race? Okay? Good? That was a test. I'm just making sure you got your ticketres right there. So say say, I'm a guy in the elevator there on the Starship Enterprise with you when and you've got two minutes to to tell me? Uh, you know, sell me on the CTF. What it's an active ETF, So what you know, what's the selling point for it? As far as your methodology and how you construct the portfolio compared to say the f x I, you know, the index tracking passive ETF. That's US investors are pretty familiar with. What's what's your sales pitch. Well, if you want to access China right, UH, you want to access China actively. And that's because a capweight to passive index UH doesn't make sense for a very inefficient market where in the short run, lots of great companies are underprised and lots of back companies are overprized UH, and where you know, giving you know, doing some research is going to give you an edge in terms of knowing what the informed institutions are buying, perhaps knowing what the informed UH and and well plugged in people who understand policy shoots are buying and doing so the active approach is certainly going to help you. Additionally, by the you know, low price, good quality firms that will grow and avoid I think a lot of the hype, a lot of stories, a lot of firms that do eventually become regulatory risk, either because of poor governance or because you know, sort of just general pool compliance with the regulatory environment. So you gotta go active in the market. That's retail traded, Jason. One of the rationales I heard for the crackdown on the CRAM schools was tryinga's three child policy. You know, they want to encourage UH families to have three children, and obviously if you have to pay for three sets of cram schools, that's gonna get gonna get pretty expensive. Um. But I wonder that's a fascinating concept to me because here in the US, we have a hard time getting people to wear a mask, you know, to to stop a virus or get a free vaccination. Uh, you know, we have a hard time having the government getting people to to anything. But in China, you know, I wonder is it harder to get couples to have three kids than to say the wonder child policy? And how important is that of apolicies? First, the economy and how you're thinking about investments, does it play into it at all, this potential for for a sort of a baby boom relative to what China has seen in recent generations. Okay, so first of all, you're absolutely right. I think it is probably far more difficult today to ask you know, Chinese couples to have kids than to not have kids. And then again, and that's more of an Asian phenomenon today, right, if you look at Taiwan and you look at South Korea, like the birthrate per couple is is less than one, right, So that's that's obviously very bad for demographics. Right, that's very bad for looking at consumption growth, you know, ten twenty years down a row. When when you have such a you know, rapidly dropping population, kids are very expensive. As a father of freaking I will tell you you met your quota and talking about you done well, done well, yeah, and as the kids are very expensive from both a financial resourcing perspective, but also for young couples in China today right where there's a lot more I think opportunities to make more money change your quality of life. So you start to think about, hey, you know I have opportunity costs. Right when I'm raising kids, I I'm maybe not out there making money or spending money, given that I'm able to make a lot more money now. So I think what we're seeing is really an issue we see in developed markets, right, you know, as as economy evolves developed um, people's willingness or the need to have more children simply have declined. So that's just something I don't think you could mandate easily and change now. Of course, you know the government has sort of gone out and try to research what's stopping young couples from having to you know, having kids or wanting to have kids, and you know that the responses, unsurprisingly have been so expensive. Race kids are part of the cram school. Part of it is um uh, you know, real estate, right because if you want to be in areas that are safer, nicer, better school um that real estate is expensive. Of the government's also been talking about, you know, how to how to change or you know, influence real estate prices so that that it's not so expensive for for for people to have access to good school districts and so on and so forth. But I don't think that will solve everything, right d These are on the margin issues, but they're not all the totality of the issues. Um So, I think the regulators and then the policymakers in China are going to find it frustrating that they're they're they're trying to do so much, but the the the out the outputs, the outcomes may not may not actually be as meaningful. Let's say they're hoping to achieve play some romantic music over loudspeakers or something. I don't know, I don't know. Yeah, we'll see what stand clear. Of the craziest things we saw in markets this week, well, With that said, guys, I can't let you go without partaking in our tradition. And Jason, I hope they weren't about this, but we have a tradition here. We we end each show with the craziest things we saw in markets during the week. Yeah, I have a feeling you got something crazy for us. I want to start with you. Yes, it's actually related to the three child policy. Um So Punjuhuan City, which is the city of one point two million people in southwest China's Trains province, is giving each couple each baby actually um essentially fine hundred you one, which is eighty dollars and months for families that have um second child or third child until other babies ten three. So this is the first time. It's first of China city offer cash for people to have more baby East. It's probably pretty standards in the western countries to have child subsidies, but not long ago. China. At one point China policy and into certainly attended into two China policy, and now we have a three side of policy and people are offering cash to have people who have more babies. I think that's pretty crazy. That's that that will work better than my romantic music idea. I think that's how you do it. I just offer cash. Yeah, how about you, Jason? Have you seen anything crazy in markets this week? Well? I think the craziest thing I saw was the massive rebound, uh you know in the educational sector. Well, essentially, if you read the policy announcement, these firms should be worth pretty dying close to zero. But somehow there's still people who are willing to jump in and catch a falling knife hoping there is a rebound, right, And so I found that pretty crazy, right, you know, people are not doing their homeboorking. That is pretty good. Yeah, I mean I wonder how long it's gonna take to sort of, you know, remove the profitability from these companies. It's that is crazy though that Yeah, you're right though, why would they why would anyone pay anything for them? At this point? If literally that the regulator says, like the firm you're buying, we are going to make them into nonprofits, meaning they're not going to pay a dividend, right, they're not allowed to make up profit. But somehow you still want to become a shareholder. Yeah, that's just good. That's a good one. That's a crazy one. All right, I'll give you guys mine I uh listeners know, I like the alternative assets, and the more alternative the asset class, the better. So I bring to an auction that's going to happen next month in Great Britain. They're auctioning off one slice of wedding cake from the wedding of Prince Charles and Princess Diana forty years ago. Someone's still available. Yes, yes, someone saved one piece of wedding cake. I'll just and I hate to say it to you, guys. We have to play prices right with me now here, I'm gonna ask you each what you think the expected bid is for this piece of wedding cake. Put those quad skills to work, Jason, and let you know here it's ice came from. They're actually twenty three and as far as supply goes, there were twenty three official wedding cakes for that wedding. Pretty amazing happened almost forty years ago, exactly. Uh July one features a Marza pan bass and a sugar on like coat of arms colored in gold, red, blue and silver on top. I was given to Uh, one of the household servants of the Queen Mother and she kept this thing for all these years. Um, so it hasn't got on auction yet, so who knows what the actual price will be? But what do you guys think to two part question again start with you what do you think that the expected bid is for this in British pounds? And second part is would you take a taste of this wedding cake? I was trying to say ten bitcoins, and so we are talking about alternate to that assets, but we can't do the conversion to the British pounds. No, and no, I won't take a bite on the bit to the cake. Smart man. Ten bitcoins? That that puts it up the posts thirty thousand British pounds. Jason, how about you? You're going over under that? Oh? I well, I think he's a ten bitcoin so that that makes about three three hundred of thousand pounds. You know, being being from Boston where I I track, you know Tom Brady's progression, even though he's moved on to a different city. Now I know his his rookie his rookie card fetch something like one point three million. Uh last time I got auction. Uh. And then it's it's not the only car left in the world unlike this, this piece of wedding cake. Right, so I gotta I gotta say the wedding cakes gotta fit something like let's just say one point five million pounds. How's that? And when it's that expensive, I'm not going to take a bite. I will say it's Dominic Winter auctioneers. I imagine they would like both of you two to be bidding in this auction, because not about this up is the surprising low value they think. They're thinking only five pounds. I think it's gonna go We're gonna have to check back on this in August when it actually goes up, because I think it's gonna go for a lot more than five five pounds. I might buy the thing myself. I think they're way off, and they're expected bid on that. Maybe that's a way to drum up interest and get get people up bidding on it. But a similar piece of cake sold in nineteen I think, um, right after Princess Diana died for like a hundred and fifty thousand pounds, So depreciating asset. Wedding wedding takes are appreciating asset. The only question I have is how do they'll send that cake. How do you very fine from the wedding they well, they have it comes with some kind of documentation. I'd have to look up the story, but there is um the the servant who collected it. It was given to her. I think i's just leftovers, like here, you want some cake? And she knew that this might be worth a few bucks, so she tucked it away and she wrote on top of it, wedding cake from Princess Diinas. So there's some kind of These auction houses are good at authenticating this stuff. I'm not I'm not sure how, but I it would be a pretty good scam to have a forty year old piece of wedding cake was not Actually they somehow turned us into an n f T. It might be what even more right and NC is someone actually eating the thing? And then you saw that for that? Might that you might get your million and a half for that, But we'll see. I'm gonna check back because I think you guys were in the right direction. I think it's gonna go a lot more than what they expected, right, because people pay crazy money for crazy things. Is that's that's the lesson of this segment. I think, so but guys really enjoyed this conversation. Jason, Sue and yees She. Thank you both for your time. Jason, I know it's earlier where you are, so thank you for getting up early for us. And uh, absolutely and get back to the flight deck there of the U S S Enterprise What Goes Up. We'll be back next week and so then you can find us on the Bloomberg Terminal, website and app or wherever you get your podcasts. We'd love it if you took the time to rate and review the show on Apple Podcasts, so more listeners can find us. And you can find us on Twitter, follow me at ring Anonymous, ye she is at she Bloomberg. You can also follow Bloomberg Podcasts at podcasts and thank you to Charlie Pelle to Bloomberg Radio and the voice of the New York City Subway System. What Goes Up is produced by Tofur forheas the head of Bloomberg Podcasts is Francesco Levi. Thanks for listening, See you next time.

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