Idea Brunch with Xin Wu of Banyan Partners
Welcome to Sunday’s Idea Brunch, your interview series with great off-the-beaten-path investors. We are very excited to interview Xin Wu!
Xin is the CEO of Banyan Partners, which he founded in 2010. Out of Shanghai they invest in public Chinese companies with a Value Investing philosophy and a long/short strategy. Xin’s 30+ years career in finance started with investment banking in Silicon Valley and evolved into principal investing that covered all the stages of a company’s development including venture capital, private equity, leveraged buyout, and now hedge fund investing.
Xin, thanks for doing Sunday’s Idea Brunch! Can you please tell readers a little more about your background and why you decided to launch Banyan Partners?
Thanks for having me, Edwin! I was born in Shanghai and moved to New York at the age of 12 in the early eighties. After graduating from Stanford in 1994 with a master’s degree in engineering, I spent three years as an investment banker at the Silicon Valley investment bank Robertson, Stephens & Company. During this period, just before the DotCom bubble, many investment banks in Silicon Valley were seeking professionals who could comprehend the technology behind the ventures they were raising money for.
While those years were insightful, I wanted to transition from being an intermediary to becoming a principal investor with real skin in the game. Therefore, I switched to private equity and joined Chase Capital Partners. Based in Singapore and Hong Kong, our LBO/MBO fund managed over US$1 billion, focusing on controlling stake deals across all of Asia.
After another three years, I had the opportunity to return to my hometown and join one of the earliest and most active VC funds in China. During this period, the idea of transitioning from private to public markets began to take shape. Venture deals in the early 2000s in China began to include essential terms for investor protection, such as liquidation preference and anti-dilution protection. However, in practice, minority shareholders were at the mercy of the majority founder management when disputes arose. Additionally, venture investors were stuck holding their minority shares with poor prospects of resolution or exit. In contrast, public investments offer the flexibility to sell shares at any time for whatever reason, thus achieving optimal risk management.
I also observed many ventures going public prematurely, meaning there were still many weaknesses and uncertainties in their business models. Often, their stock prices faced significant declines after a single disappointing quarter. Theoretically, I could have achieved venture-type multiples of returns in a shorter amount of time than typical venture deal holding periods by applying value investing and taking advantage of the market’s wild swings. This realization hit me hard: it is possible to achieve VC-type high returns in the public market while exercising proper risk control at all times of holding.
After this eye-opening realization, I teamed up with a partner experienced in public investing to found my first hedge fund. We combined a private equity philosophy with public market tools, applying a long/short strategy within the China-centric equities universe. We had a good run in the years leading up to the 2008/2009 Global Financial Crisis caused by the Subprime Meltdown in the US. As a consequence, we faced significant challenges with investor funding. My partner shifted his career, but I founded a new company, Banyan Partners, to pursue the same goal, maintaining the same investment philosophy and strategy. My persistence and hard work paid off soon after, with fresh capital and new partners.
For an investor looking to add China exposure, why is investing in Banyan better than buying a China index?
As in any market, if you are seeking average returns, picking an index in China can be a sound strategy and allow you to enjoy the peace of mind of being passive. However, a recent report by UBS stated that the dispersion of returns in China is higher than in the US and Europe. This means individual stock returns deviate more from the average, allowing for greater potential outperformance in both long and short positions compared to other countries. In other words, market conditions in Chinese equities offer skilled fund managers opportunities to deliver better risk-adjusted returns.
We at Banyan have been very successful in utilizing this market condition by consistently identifying the winners and losers. Over the last eight years, we have outperformed the CSI 300 every year, returning over 8% annually to our investors, while the CSI 300 has delivered less than 0.5%. Because we short single stocks instead of an index, our shorts are also a separate profit center while at the same time protecting us against systematic risks.
We are convinced that we will continue to outperform with our strategy due to the following three strengths. First, our unique quantitative and qualitative capabilities stem from my education as an engineer and a business owner mindset due to my background in private markets. This blend permeates the entire culture at Banyan and has led to the development of proprietary databases, models, and algorithms that drive efficiency in our data-driven fundamental investment process.
Secondly, the whole team has a unique understanding of the Chinese market. Our extensive global network, built upon the diverse backgrounds of our team members, provides unparalleled access to key figures within global business circles and especially within China. Having the right connections with experts is invaluable for navigating the complexities of this vast and regionally diverse country, coupled with numerous regulations and policies where information is often untransparent and cryptic.
Thirdly, we are long-term oriented and have aligned interests with our investors. Our core team has worked together for over 14 years, with an average of more than 25 years of experience in finance. Both the core team and all employees have a significant portion of their own money invested in the fund, ensuring aligned interests between our investors and the investment team. We treat our investors' money as our own, succeeding only when investors succeed. We are prudent stewards of our investors’ capital, which is especially important in a country like China, where from the outside looking in, it is very hard to get a grip.
How does being located in China help you in your investment process?
Being located in China helps immensely. China is vast and highly diverse. Unlike the United States, which is relatively uniform with one official language and similarly developed cities and states, China is more akin to Europe. While people can generally understand each other, the existence of different spoken and written languages and vastly different business practices in different regions means that effective communication can be challenging. The contrast between Tier 1 cities like Shanghai and Beijing and the over 700 Tier 2 to Tier 5 cities is significant in terms of culture and development. Judging China from the US or even from Hong Kong is very difficult, if not impossible. It is one thing to read about hypercompetitiveness in China’s EV market, but another to witness 100 different EV brands driving by on a street corner.
You are not going to understand the real China by sitting in an office in Shanghai or Beijing, let alone New York or Hong Kong. To truly understand and take the pulse of what’s happening in real China, we need our network to extend far and wide. While we may not have employees in every corner, we have friends, associates, and a robust professional network. Without being part of this ecosystem for many years, it is impossible to gain real insights and make judgments on which companies truly have sustainable competitive advantages.
What are some of the ways the Chinese equity market differs from the U.S. equity market? Do you feel U.S. investors have any misconceptions about the Chinese markets?
The biggest difference lies in the market participants. In the Chinese A-shares market, 80% of the volume is contributed by retail investors, whereas in the US, it is less than 10%. To illustrate this, we can say that Mr. Market in the US is lazy, while Mr. Market in China is crazy. In the US, you might find small stocks that neither institutions nor retail investors look at, allowing you to find potential value. However, in China, this is not the case. Even the small caps are under constant surveillance. This can be further illustrated by a slang used by local investors: “炒新，炒小，炒差” which translates to "speculate on new, small, and bad companies." This leads to a very interesting valuation structure. While everyone thinks Chinese stocks are cheap currently, this is only true for the top companies such as the constituents in the CSI 300, the largest 300 companies valued at an average P/E of around 12. The next 500 companies have a P/E of 23, the next 1000 have a P/E of 37, and the last 2000 have a P/E of 59! This creates a very interesting hunting ground for rational investors with a long-term fundamental strategy to take advantage of the low valuation of the biggest and best companies and short the bad small companies once their business models deteriorate and even the speculators lose hope. That being said, we want to highlight that the current market characteristics will not remain constant.
We believe there are many misconceptions about Chinese markets, the biggest might be that every Chinese company is engaged in fraud and that their numbers cannot be trusted. While it is true that there have been fraudulent companies in China, this issue is not unique to China; it also occurs in the US and Europe. However, we believe that the instances of fraud in China are often magnified more than any positive news, leading to a biased perception against Chinese companies. Fraud is a cat-and-mouse game worldwide, but from our analysis, regulatory oversight is much stricter in China. Reporting standards have been continually improving, and the rules are more standardized than elsewhere, significantly limiting “creative accounting.”
Another commendable tool to protect investors is the Inquiry System introduced by the local stock exchanges. Professional teams from the stock exchanges are dedicated to spotting irregularities in financial statements and other deal-related public disclosures and issuing public formal inquiries that the recipient companies must reply to within a limited number of days. Especially during earnings season, these inquiries pose confrontational questions when irregularities are detected in newly reported statements. We have seen previous inquiries asking questions as direct as whether a company's cash is real, requiring supporting bank documents and verification by auditors. Over the past eight years since the start of this Inquiry System, the volume of inquiries has steadily increased. This method, coupled with very harsh jail sentences for fraud and the general improvement in disclosure, means we do not blanketly write off the quality of the financial statements from Chinese companies. We believe the quality of the disclosures for a securities analyst to do research is on par with Western markets.