This is our first year-end letter, written from a region still finding its footing. We had imagined we would write to friends and partners about deal flow and theses; instead we find ourselves writing about what we did not do, and why we are glad we did not. The shape of a useful first letter, we have decided, is not a list of accomplishments. It is an honest accounting of the year's instincts and which of them we chose to follow.
On the Crisis That Made Our First Year
The Asian financial crisis ran longer than we expected. By August it had reached Russia; by September, Long-Term Capital Management; by October it had touched, in some way, almost every fund in the region. We began our first year of operations in conditions that would have been considered career-ending capital-allocation environments for any institutional fund. We chose to interpret them differently.
A crisis is the only environment in which the price of a good company can fall to a level that justifies a long hold. Most of what passes for value investing during normal markets is, in our reading, marginal-quality businesses purchased at marginal discounts. Real value investing — the kind that compounds for decades — requires conditions that occur rarely. The conditions of this year were rare. The work, in such a year, is not about deal flow. It is about discrimination.
We have asked ourselves, throughout this year, whether we are simply rationalizing inactivity. The honest answer is that some of our slowness was timidity rather than discipline; we are not so confident in our framework that we cannot admit this. But the majority of what we declined, we declined for reasons we still endorse on review.
On the Companies We Could Have Bought (And Did Not)
By the fourth quarter we had a list of approximately forty Asian businesses available at distressed valuations. We invested in three. We turned away the other thirty-seven not because the prices were wrong but because the businesses were wrong — companies whose problems were not cyclical but structural, masquerading as opportunities because of the noise.
The temptation, when prices fall by sixty or seventy percent, is to assume that the underlying assets must therefore be undervalued. The error in that assumption is that crisis pricing is not uniform across qualities; it is most generous to assets whose normal price was already being supported by enthusiasm rather than by fundamentals. The cheapest things in a crisis are the things that should never have been valuable. We have a notebook of cases this year that confirm this asymmetry.
This is the discipline we want to be remembered for. In a normal year, we will turn down ninety percent of what we see. In this year, we turned down ninety-three percent. The shape of the discipline does not change because the environment did. We are, in fact, slightly more proud of the year's rejections than of the year's investments. The rejections are the harder work.
On What Cheap Capital Disguises
We have seen, this year, fund managers whose 1996 vintages looked excellent ride the same logic into 1998 and discover that what they thought was investing acumen was actually the carry of a market wave. Several of them have closed shops or merged into larger firms in the past six months. We have learned to be wary, when reading manager track records, of vintages that span only one direction of a cycle.
The crisis has not yet reached venture in our region in proportion. When it does — and we expect it will, with a lag — the lesson will be the same: low-cost capital obscures everything beneath it. Governance, business quality, founder seriousness. The water has not yet receded enough.
We have, on this thesis, increased our minimum diligence period for new commitments to ninety days. The longer we sit with a deal, the more visibly the marginal opportunities reveal themselves as marginal. Several investments that looked attractive in week two looked obviously wrong in week ten. We have begun to suspect that ninety days may not be long enough.
On the First Investments We Made
Our three initial commitments are in companies whose founders had personal capital at risk before we arrived. This was not a stated criterion in our founding memo — but in retrospect we believe it should have been. A founder who has not committed personally is a founder who has not yet decided. We will not commit before they do. We have added this, quietly, to our internal investment-committee template; it will appear in next year's memos when relevant.
We will not write at length about the three. They will appear in future letters as their stories develop. We will say only that we underwrote them not on the basis of their stated five-year plans, but on the basis of how they had behaved during the months in which the plans were impossible to execute.
A Closing Note
We expected to spend our first year learning how to find good companies. Instead we spent it learning how to refuse bad ones. We are not certain which is the more durable skill, but we suspect it is the second. The first can be taught. The second has to be practiced.
Thank you for reading this letter. There will be many more. We will write one every December for as long as we are operating, and if we are still doing this work in 2027 — which we hope to be — we will look back on this letter as the first time we wrote down what we were trying to be.
The Partners
Winzheng Family Investment Fund · December 1998