Mr. Munger recently made a somewhat surprising announcement to the effect that Li Lu is basically one of the projected capital allocators for Berkshire Hathaway when he was quoted in a recent WSJ article stating ""In my mind, it's a foregone conclusion". There has been a mixed reaction to this article I and thought it would be interesting to blog about what Charlie sees in him and to see how Li Lu approaches investing.
The article relates the only solid return data that I have seen to date about his investment returns which, according to the WSJ article, his "...hedge funds have garnered an annualized compound return of 26.4% since 1998, compared to 2.25% for the Standard & Poor's 500 stock index during the same period."
I have no personal knowledge, other than what I have read (his biography about his time in China) and two videos of lectures he gave at Columbia University that I watched. I have no idea what investments he made that comprise his track records, other than an investment in Timberland and BYD. Despite this I will try and explain the reason why I think Charlie is enamored with him.
So first let's start the discussion by drawing on comments Charlie made at the 2007 Wesco annual meeting when he spoke about what characteristics had made Br. Buffett so successful.
Here is the list:
1. Mental aptitude
2. Warren has a strong interest in what he is doing
3. Warren is a learning machine. In fact Charlie said that "Warren's investing skills have markedly increased since he turned 65."
4. He is able to make his own decisions and he is very objective in making those decisions
5. He reinforces those people that are close to him
Just looking at the publically available history of Mr. Li obviously has triumphed over a number of adversities over his life which shows us that he develops firm convictions and is not deterred when his convictions conflict with others. He fought for what he believed in when he was in China, under a repressive government, he came to the United States only able to speak a minimal amount of English and ended up graduating from Columbia University. While there he developed an interest in investing that was reinforced when he listened to a lecture from Mr. Buffett.
As the article mentioned he used a portion of his book advance money to start investing. He did well and eventually stated his own hedge fund company in 1998 called Himalaya Capital (the internet site is still up and is updated. The link is: http://www.himalayacapital.com/).
Since that time he has focused on the investing field and I'm sure he has developed a process that has been refined over time into a form that Charlie obviously thinks highly of since he gave Mr. Li personal funds to invest.
I'm sure all those factors, i.e. his strength of character, obvious mental aptitude and his strong interest in investing made him interesting to Charlie. As Charlie also said at the 2007 Wesco annual meeting, "We like a peculiar mindset. People chosen won't look like standard people. Obviously we'd like to try to get somebody that reminds us of Warren."
I also thought this quote from Li Lu's foreword to the Chinese edition of Poor Charlie's Almanac is instructive of how Charlie did he due diligence on Mr. Li:
"Seven years after we've known each other, at a Thanksgiving gathering in 2003, we had a long heart-to-heart conversation. I introduced every single company I have invested in, or researched, or am interested in to Charlie and he commented on each one of them. I also asked for his advice on the problems I've encountered. Towards the end, he told me that the problems I've encountered were practically all the problems of Wall Street. The problem is with the way the Wall Street thinks. Even though Berkshire Hathaway has been such a success, there isn't any company on Wall Street that truly imitates it. If I continue on this path, my worries will never be eliminated. But if I was willing to give up this path right then, to take a path different from Wall Street, he was willing to invest. This really flattered me.
With Charlie's help, I completely reorganized the company I founded. The structure was changed into that of the early investment partnerships of Buffett and Munger (note: Buffett and Munger each had partnerships to manage their own investment portfolios) and all the shortcomings of the typical hedge funds were eliminated. Investors who stayed made long-term investment guarantees and we no longer accepted new investors.
Thus I entered another golden period in my investment career. I was no longer restricted by the various limitations of Wall Street. The numbers still fluctuate as before, but eventual result is substantial growth. From the fourth quarter of 2004 to the end of 2009, the new fund returned an annual compound growth rate of 36% after deducting operating costs. From the inception of the fund in January 1998, the fund returned an annual compound growth rate in excess of 29%. In 12 years, the capital grew more than 20 folds."
So what does Mr. Li say about his investing philosophy. His quotes are few and far between but I was able to locate a few. This first quote is from a May 1998 article in the New York Observer by Carrie Cunningham (http://www.observer.com/node/40526):
"Mr. Li said he likes to buy stocks that are undervalued, in his estimation. That goes against the currently fashionable "momentum" theory used by investors who believe they can ride an overvalued stock that is still soaring in price, and then jump out before the stock comes crashing back down.
"If you're right, ultimately it will prove you're right, but you look stupid for a long time," he said of his own gambits. "It is what I'm all about. It's revolutionary. It is about trusting yourself. It's about challenging the conventional wisdom. That's what we did in Tiananmen."
This additional quote from the recent WSJ article clearly highlights the similarity between Charlie's approach to investing and Mr. Li's:
"Mr. Li told investors he took a lesson from watching the World Cup, comparing his investment style to soccer. "You may very well work extremely hard and seldom score," he says. "But occasionally—very occasionally—you get one or two great chances and you make decisive strikes that really matter."
Compare that to this quote from Charlie from the book Damn Right!:
"Playing poker in the Army and as a young lawyer honed my business skills. What you have to learn is to fold early when the odds are against you, or if you have a big edge, back it heavily because you don't get a big edge often. Opportunity comes, but it doesn't come often, so seize it when it does come."
So as you can see I think it's pretty clear why Mr. Munger concluded that Mr. Li is the right candidate. He has the right intellectual background, he is an independent thinker, he sticks to his convictions and he is not afraid of volatility. For more insight into his investment philosophy I would recommend a careful study of notes on his lectures at Columbia University which are available at: http://streetcapitalist.com/2010/06/24/li-lus-2010-lecture-at-columbia/