Sold out: my last Chinese share

Want Want China Holdings Ltd (HKSE:00151) is known for its rice crackers and Hot-Kid milk. Besides these best sellers, it offers a range of other consumer products like tea, coffee, snack food, candy, instant noodles and cookies. 90% of its sales are within Mainland China, where the company has its headquarters.

The company grows slowly: only a few percent per year in revenues. Product lines are long established, sometimes decades ago. There is some uplift from new or refreshed products if those are received well. The company's ROIC is high, but that is of limited use without growth. Most products are popular with children (Hot-Kid milk). This will raise some challenges, considering China's rapidly declining birth rates. On the other hand, Want Want's management knows this and can adapt products over time. Free cash flow and dividend yields are good. This is not the kind of share that will double, but I bought it at a reasonable price a few years ago, making it a safe investment.

Is China un-investable? Lately, we have seen a lot of publications trying to answer that question. Many argue that the Chinese government is intervening too strongly in many business sectors. Can Chinese authorities somehow disrupt the Want Want business? It is hard to imagine ideological objections against rice crackers and milk. However, there are already objections against the high sugar levels in certain products. As a 7 billion USD market-cap company, we can expect Want Want's R&D department to adapt its products to stricter standards. In conclusion, I am not overly worried about possible interventions by the Chinese authorities.

Is China investable? I don't know. I sold Want Want to prevent this question from keeping me awake at night. It was my last remaining Chinese share and 2% of my total portfolio. I had already sold my other Chinese shares (Yihai, Nissin Foods, Uni-President, China Foods, WH Group, Natural Foods, Da Ren Tang Group, and Guangzhou Baiyunshan) for company-specific reasons.

By selling Want Want, I free up a lot of my mental space by not having to understand the economic and ideological intentions of the Chinese government. I have no more horses in that race. It feels as liberating as selling Daiwa House Logistics Trust in September 2023. I was comfortable with Daiwa House, but since it was the last Japanese company as well as the last REIT in my portfolio, selling it created a lot of space for not having to think about Japan and REITs anymore. 

I have Chinese and Japanese companies on my watchlist, as well as REITs. When a considerable margin-of-safety arises in their share prices, I might purchase some again. A large margin-of-safety compensates for the macroeconomic worries related to these categories. But right now, Want Want is not in deep-value territory.

Disclosure: No more positions in the stocks mentioned.

Sold: a bunch of smaller positions

I started to reduce the number of shares in my portfolio, as described in my last blog. First, I decided which 4% positions to top up to 5% and which 1% positions to double to 2%. To finance these top-ups, I sold all the remaining positions where I did not feel comfortable to top them up. I already described a bunch of earlier sells. Here are some more shares that didn't make the cut.

Sold: Tong Ren Tang Technologies Co Ltd (HKEX:1666), Tianjin Pharmaceutical Da Ren Tang Group Corp Ltd (SGX:T14), Guangzhou Baiyunshan Pharmaceutical (HKSE:00874)

These companies are Chinese state-owned enterprises (SOE) that make and sell traditional Chinese medicine (TCM) products. I bought all three simultaneously to diversify the risks because I do not have the sector knowledge to select specific companies. I do not speak Chinese, and I don't have access to sales channels like WeChat and Taobao. I can't evaluate which of the three companies is doing best. I changed my vision on portfolio management since these buys. I abandoned this basket-type strategy and started focusing on companies I can study in detail. It was time to sell off this TCM basket to make room for this new approach. I booked a good overall profit thanks to Tianjin Pharmaceutical Da Ren Tang Group Corp Ltd.'s significant share price increase. It was more luck than wisdom. 

Sold: Natural Food International Holding Ltd (HKEX:1837)

This company sells healthy food and snacks, mainly breakfast cereals. This food category is still a small and fragmented market in mainland China. The sector holds a promising future with an increased focus on health by consumers. Natural Food International is backed by PepsiCo Inc., with all its knowledge and experience, as a minority shareholder. Yet, Natural Food's revenues and earnings have not grown much during the last few years. The stock has been a value stock all this time with a P/B below 1 and a P/E of currently 6. Dividends were cancelled in 2022 and 2023, although the company had and still has plenty of cash in the bank. 

The company's market cap of 129M USD violates my minimal market cap rule for Chinese companies. At the time, I decided to allow this rule violation because of PepsiCo's involvement. However, it is possible that I obtained too much trust from that involvement. The value of the participation is small potatoes for a global corporation like PepsiCo. It could be a venture capital type of investment for them. 

All considered, I did not dare to top up Natural Food from 1% to 2% in my portfolio reorganization. I see some red flags, and I do not have much information to ease those worries. 

Sold: PT Uni-Charm Indonesia Tbk (ISX:UCID)

Uni-Charm sells paper diapers under the name MamyPoko. One year ago, I bought this share as a long-term bet on a rising Indonesian population. A rising middle class should create a growing demand for higher-quality household products like diapers. The diapers that Uni-Charm Indonesia sells have been developed by Japanese multi-national Unicharm Corp. Pulp and paper are the main commodities used for the production of diapers. The market prices of these commodities are much more volatile than I had realized when buying the share. As a result, the margins of Uni-Charm fluctuate a lot too. The company is not as financially boring as a typical consumer staples producer. In addition, the stock price keeps going down.

Uni-Charm Indonesia is a joint venture between Unicharm Corp and  PT APP Purinusa Ekapersada, an Indonesian paper & pulp manufacturer owned by Sinarmas Group, a vehicle of the Widjaja family. A combination of a multi-national company and a local family enterprise is perhaps not ideal. Both joint-venture partners are also suppliers to Uni-Charm Indonesia. This creates an opportunity to siphon off Uni-Charm's profits by charging supply prices higher than market prices. Should this ever happen, it will be almost impossible to detect. In summary, I did not have the confidence to top-up this share and sold it off. 

Sold: Kotra Industries Bhd (0002.KL)

I recently bought this share, also known as Kotra Pharma. As you can read in the blog post, I already wondered whether I truly understood their prescribed medicine division. The pharmaceutical business can not be analysed in the same manner as the over-the-counter Appeton product division. I lack insights into factors such as pharmaceutical development pipelines and regulations. I did not have the conviction to top up Kotra, so I decided to sell it.  

Disclosure: No more positions in the shares mentioned. 

My position sizing system

• 5% initial position for a company incorporated in a developed market
• 2% initial position for a company incorporated in an emerging market

My old position sizing system was a two percent initial buy plus an additional two percent later for companies incorporated in a developed market. I usually did this second buy after a few months of holding the first portion. The purpose of this lag was to get comfortable with the company in the meantime. Sometimes, I did not get such comfort and sold the share. Similarly, I bought half percent positions plus a half percent later on in emerging market companies. It was a careful start because I started a whole new portfolio. However, I ended up holding 75 shares. There is no way to follow 75 companies as a part-time private investor. 

There is a lot of research addressing the proper diversification of a stock portfolio. I believe the picture below illustrates somewhat of a consensus conclusion.

We can see that a portfolio with only one stock results in a huge standard deviation of its annual returns. Adding one stock reduces this standard deviation considerably. Assuming that the added stocks are equally weighted, the variability of the total portfolio goes down as we add more stocks. At some point, let's say at 25 stocks where the arrow is placed in the graph, adding stocks does not reduce variability in any significant way. 

The graph is compiled by looking at a large number of portfolios. We are looking at reality, not a theory. Nevertheless, this perspective on diversification is debated. Many value investors argue that variability does not represent risk; only permanent loss of capital does. The number of shares does not matter either, but rather how confident you are about the business prospects of the underlying companies after intense research. Charlie Munger was not afraid to hold only three shares. However, I do not have the quality of information, insight, experience, and advisors that Charlie Munger had access to. For now, I will go with the traditional concept of risk as expressed by the diversification graph above. 

In any case, I was severely over-diversified, holding 75 shares. It will be nearly impossible to beat an index fund with so many shares. I already experienced that a very successful 0.5% position, such as my triple return with Luckin Coffee, will barely affect my overall portfolio performance. I concluded that my 1% positions in emerging markets China, Thailand, Malaysia and Indonesia did not make sense. I decided to take 5% positions in Malaysian companies from now on. For China, Thailand, Indonesia, and other emerging markets I will allocate 2% per company. That is still a small allocation, but I currently do not have the confidence to take a 5% position per company in these markets.

The reorganization

After deciding on my new position sizing rules, it was time to take action. I sold off a bunch of shares where I did not have the conviction to top them up to 5% or to 2% for a range of different reasons. This was a useful exercise in itself. I increased the allocations of all the remaining holdings, except for Greggs, ABF, Reckitt and Haleon, which already got too expensive. In the case of turn-around situation LG H&H, I want to wait for the Q4 2023 results. With the reorganization mostly done, I own 25 shares now. 

Further concentration?

Looking at the chart above, I could reduce my 25 positions further to 10 positions. The variability of the portfolio as a whole would not increase that much. I could start with taking 5% positions to 10% where I feel confident that a company is extremely undervalued, such as Boustead Singapore and Ibersol. However, from my past experiences as an investor, I have learned that my ex-ante level of confidence is often misplaced and irrelevant. There is no correlation between my level of confidence in a share pick and the subsequent performance of that share. 

As an example, my current best performers are Exotic Food PCL, Tianjin Pharmaceutical Da Ren Tang Group Corp Ltd and Associated British Foods PLC. I would never have guessed these picks as being my winners two years ago. I would probably have guessed Alibaba or Tencent then. Without a mechanical allocation system, I would have doubled down on these two stocks. This doubling-down behaviour is known as Get‐Evenitis or, more officially, loss-aversion bias. A mechanical sizing system is an antidote to this bias. It saved me from a bigger disaster in the Chinese tech space. 

Hence, I will stick to my mechanical allocation system. Should I ever change the current 5% and 2% sizing numbers, it will be wise to apply the new rules to all my shares, not to a selection.  

Disclosure: long position in all the shares mentioned, except Alibaba, Tencent, Tianjin Pharmaceutical Da Ren Tang Group Corp Ltd and Luckin Coffee, which I sold off