23 October 2016
Blue Moon built a billion-dollar business from scratch in five years, becoming the dominant player in China's liquid detergent segment. Photo: Lab Brand
Blue Moon built a billion-dollar business from scratch in five years, becoming the dominant player in China's liquid detergent segment. Photo: Lab Brand

Long-term investment cannot exist in a vacuum

A common sentiment among investors in China is that the best way to make money is to trade frequently, lest you end up holding the short straw. But, in my experience, buying and holding great businesses is the only way to achieve excellent returns.

Other investors often tell me that they would like to invest for the long term, but that their fiduciary duty to their clients bars them from doing so.

There is some truth in this sentiment. Great long-term investments are simple in theory, but difficult to execute; they will undoubtedly test your patience and resolve, especially if you face steep interim losses.

That is why a successful long-term strategy requires the backing of investment partners who trust you and are willing to be patient.

Fund managers who are under constant pressure to post profits or defend short-term results cannot afford to invest with entrepreneurs building businesses that are optimized for the next 10 years, rather than for the next quarter.

My firm’s relationship with the founders of the detergent maker Blue Moon, Luo Qiuping and Pan Dong, exemplifies this idea.

In 2006, their company was a leader in liquid hand soap. Their business was growing organically, and Luo and Pan were not looking for investors.

But we kept in touch with them, often sharing our thoughts on the global household/personal-care industry.

Then, in 2008, the company had a small breakthrough with a new type of liquid clothing detergent. At the time, multinationals had a big presence in the Chinese powder-detergent market. Liquid detergents were a premium product, and the Chinese were thought to be too cost-conscious to use them.

But we believed that Blue Moon had a window of opportunity to seize the liquid-detergent market in China.

Globally, this market stood at nearly US$20 billion; it seemed inconceivable that the rise of the Chinese consumer would not add to this number.

Encouraged by our discussions, Blue Moon made a significant investment in liquid detergents, spending heavily on manufacturing, marketing and distribution.

The move transformed a small firm with steady profits into a loss-making enterprise with the potential to become a multibillion-dollar powerhouse.

But, with Hillhouse as one of its only significant external shareholders, the company became an early pioneer in China in creating homegrown premium products.

Blue Moon built a billion-dollar business from scratch in five years, becoming the dominant player in the liquid-detergent segment, with a brand that is viewed more positively than its multinational competitors.

Many Chinese entrepreneurs share similar stories of sacrificing short-term profits for long-term position.

Tencent, now one of the largest internet companies in the world, intentionally under-monetized its early social network, QQ, for many years in order to focus on consumer experience.

In its start-up years, search giant Baidu cut a profitable SMS-advertising business in order to focus on its core product: search.

Portfolio managers take on risk when they “change horses”, reallocating from a company they know well to a new investment.

By contrast, working with entrepreneurs to build their companies for the long term and strengthen their competitive legs allows capital to stay invested and reduces the risk that turnover creates.

A long-term strategy must extend to research, with employees encouraged to look beyond the short term. When a team member has a good idea, he or she should spend months, even years, learning as much as possible about the business or sector without the pressure of finding a commercial application.

My firm has done well by any measure over the past 10 years, but not without periods of underperformance.

We can hold onto companies with strong long-term fundamentals but poor-performing stock prices because our investors understand what we are doing and give us the leeway to execute our strategy.

This underscores the fact that long-term investing cannot exist in a vacuum; it needs a supportive ecosystem.

The short-term mentality of some market players may provide some interesting trading opportunities, but it impedes the development of a system in which innovation thrives.

Entrepreneurs cannot reach their full potential without staunch support from investors, and investors cannot provide that support without the backing of their clients.

In China, I have organized a group of equity investors to share ideas and insights about fundamental investing, and I help start-up fund managers who share a long-term philosophy get their businesses off the ground.

Even a few of my own team have questioned why I am so eager to develop potential competitors.

The reason is simple: the pie is big enough for everyone – or will be if we work together to make it grow.

Copyright: Project Syndicate

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Founder and Chief Investment Officer of Hillhouse Capital Management

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