Anthony Bolton, the legendary money manager failed in China, a country where the rules regarding fraud are hardly relevant since the government has a monopoly on information. Mr Bolton not only violated his own rules of investment but he failed to learn the Chinese ones
Anthony Bolton is a legendary money manager. He managed Fidelity International Special Situations Fund for 28 years. During that time the fund managed to deliver an incredible annualized return of 19%. Among Mr Bolton’s many accomplishments was to predict both the collapse of the market and the beginning of the bull market. In both cases he was a bit early. He warned that the bull market was overstretched in November of 2006, a year before it hit its top, and he predicted a turnaround in the markets in October of 2008, five months before it hit the bottom. Still if you had followed these recommendations you would have missed out on the top 15% and lost about 25%, but only for seven months. Over time you would done very, very well.
In 2010 Mr Bolton was tempted out of retirement to apply his legendary skills to the greatest growth market, China. What better place for a money manager of his calibre? China was the fastest growing economy on the planet. Mr Bolton hailed it as “investment opportunity of the next decade”. So in April 2010 he started his new fund, Fidelity China Special Situations PLC (FCSS.L), with about $700 million dollars and began to invest in China. But it didn’t work.
Initially the fund did well. By November 2011 it had increased from 100 British pound sterling (GBP) to 124 GBP. Then things began to go wrong. It fell to a low of 71 GBP last September and is now trading at 83 GBP, off 17% over three years. In contrast the S&P 500 has increased 30% over the same period of time. What went wrong? Quite simple. The rules were different and no one told Mr Bolton.
Western managers are used to dealing with developed market economies subject to enforced rules and regulations. Over many decades, financial analysts and economists have done countless studies into how these markets actually work. They use a variety of analytic financial tools to try to determine value. For example the most general tool is the earnings per share. The most common measure of how much money the company is earning for its shareholders. Money managers are always trying to determine if the company is consistent. Is it transparent? Do the managers have a good track record of creating value for their shareholders? Is it increasing market share? Can the company’s growth be translated into corporate profits?
Money managers employ vast armies of analysts, each vying with each other to discover some salient fact about the company to determine if in fact there is substance to its numbers. Although Mr Bolton did not speak or read Chinese he could rely on a very experienced team. Fidelity had an established research presence in China. Its flagship China Focus Fund managed stocks worth $4 billion. It is managed by Martha Wang, who was born, raised and educated in China. She has over 20 years of experience investing in China. In addition there were 30 regional analysts and 18 portfolio managers. So Mr Bolton had the brain power to analyze a market, a western market.
But the Chinese market and most emerging markets do not work with the same rules. China is a particular problem because of the level of government involvement in the economy. The vast preponderance, if not all, of listed companies are at least majority state owned. Senior management appointments are made by the Communist party. Even fully private companies are not free from at least government influence over the management. For state-owned companies profit and shareholder value often takes second place to political considerations.
Even when the management does focus on business yardsticks for success are different than in Western countries. Western managers will focus on earnings growth and profit. Chinese are more interested in size, market share and increasing revenue than margins.
The legal system in developed countries is taken for granted by investors. Since it has been around for so long and is generally enforced, its affects on the market and valuation are unseen. Not so in China. China has laws, but they are enforced selectively when they are enforced at all. Recently China’s theft of US intellectual property has been in the headlines. But there is little to keep the Chinese from stealing from each other. So a major competitive advantage could disappear overnight.
Over ten years ago when I wrote Investing in China, I quoted a famous Chinese scholar who made the statement that the stock market was little more than a casino. Little has changed. Share value is driven often by speculation. The market is subject to manipulation, insider trading and government interference. While China’s economy has grown dramatically over the past five years, the Shanghai Composite index is actually lower than it was in June 2009.
Mr Bolton’s first mistake was not to translate his tool kit to adapt to socialism with the Chinese characteristic. His second was much greater. He also ignored the most important factor for any investor—the need for complete, timely and accurate information. Western investors just assume that people are telling them the truth. They have not bothered to do a simple economic analysis. Information has value. It is accurate only if the economic incentives are less than the legal disincentives. If you can commit fraud without punishment, then there is no reason to tell the truth. In China the rules regarding fraud are hardly relevant in a country where the government has a monopoly on information.
So Mr Bolton trusted management to his loss. For example he invested in China Integrated Companies which lost 90% of its value after it was accused of fraud and its auditor KPMG resigned. He also lost money by investing in a small-cap fund whose main asset was China Integrated Energy (CBEH). It had falsely reported the level of sales of its bio-diesel product. Mr Bolton thought that his best bet was to beef up his staff for better due diligence and remained optimistic about China. But more staff is not going to help if managers are deliberately trying to distort their numbers. It is a fundamental principal of law and economics that managers as agents will always act in their own best interests unless there is a sufficient legal disincentive.
Finally Mr Bolton failed because he disregarded his own rules. In an interview in 2009 Mr Bolton said he looked at three factors. These were the scale of the rise and fall of the markets relative to their historical averages. Second he uses several measures like put/call ratios, sentiment of advisors, and mutual funds cash positions to judge investor sentiment. Finally he looked at long-term (30 to 40 year) market valuation to see how far valuations had deviated from their norm. None of this information, which Mr Bolton deems so essential, is available in China. So Mr Bolton not only violated his own rules he failed to learn the Chinese ones.
is president of Emerging Market Strategies. An international lawyer and economist, he developed his theories beginning with his first hand experience and business dealings in the Russia starting in 1993. Mr Gamble holds two graduate law degrees. He was educated at Institute D'Etudes Politique, Trinity College, University of Miami School of Law, and University of Virginia Darden Graduate School of Business Administration. He was a member of the bar in three states, over four different federal courts and has spoken four languages.)