Dear Fund Investors/IOU Holders,

Introduction
Since the inception of this fund on the 21^st March 2017 to the 3^rd of January 2018, the fund have recorded a gain of XX.XXX%. Depending on the date of your investment, or investment structure with me, your returns is likely to differ.

This result, is currently ahead of FD: 4.2%, 2016 EPF rates of 5.7%, and the KLSE index of 9.53%.

It is however, far below the gains of the S&P 500 index of 20.37%, the Dow Jones Industrial Average index of 26.38% or the NASDAQ NMS Composite Index of 29.47%.

The primary reason for our under performance in comparison to the US stock market indices, is due to our lack of exposure of US stock market.

Having said that, the fund is unlikely to be investing in the US stock markets for the foreseeable future (unless extenuating circumstances occur), as my circle of competence currently reside mainly in Malaysian, and to a small extent, Singaporean equities. Given time, we may expand more fully to Singaporean equities.

However, I would like to also elaborate on one other reason why I invest in Malaysian Equities. The answer is simple, it’s one of the cheapest in the world right now.

Whilst every stock market in the world posted record gains (even Japan, whose markets have finally left a 30 year stagflation), the Malaysian stock market have actually fallen in the second half of 2017, before gaining an incredible 5.8% in just 23 days, and even then, it is still 2/3 behind the gains posted by the Nasdaq.

The stock market is one of the places, where the law of economics do not work. In the real world, the cheaper the product (while value stays the same), the higher the demand. In the stock market however, the higher the price, the higher the demand!

This is largely driven due to, greed, the fear of missing out, and the inability to tune out the knowledge that someone else is making more money than you. God forbid it’s a neighbour, relative, colleague, classmate or family member!

There’s something about our human nature, where, if we know someone is doing better than us, it turns into special kind of hell for us. And as your fund manager, I too am human and subject to these feelings, but I think (or at least would like to) that I’m especially adept at controlling this part of our nature. Let me elaborate how.


Our investment philosophy

As this is the first letter of the fund, I think it is important that I reiterate the investment philosophy of this fund, so that everyone is up to speed.

This fund (I actually have not even thought of a name yet) is a pure value, long term only fund, managed with the intention of earning good absolute returns regardless of how any particular financial market performs.

The philosophy is implemented with a bottom-up value investment strategy whereby we hold only those securities that are significantly undervalued and hold cash when we cannot find better alternatives.

An investment philosophy such as ours will theoretically lag during a bull (rapidly rising) market, but outperform a bear (lacklustre or declining) market.

So what are our principles?
 

1. Shares are not pieces of papers with prices that change every second, but fractional shares of a business.
   
   For many people, the stock market is a casino, where one has the opportunity to buy a piece of paper (or number on a screen) in the hopes that someone down the line will be willing to pay more for it, next month, next week or even the next 5 minutes.
   
   And this is especially encouraged by your brokers who earn RM 8 + 0.12% of the transaction value, PER TRANSACTION. And given the advent of the internet, it becomes every so tempting to watch the price of the shares fluctuate every second, and one can even watch the value of ones holdings rise or fall a few hundred or a few thousand every few minutes.
   
   Naturally, this will give rise to an incredible urge to try and make money off these fluctuations. To buy when the price is at the bottom, and sell when the price is at the top. And this leads many people learning how to read the “tea leaves” of the stock market, via “technical analysis” or in layman terms, predicting the movement of prices via observing the patterns of a chart, in hope of finding an inefficiency, or even via the prediction of trends.
   
   Except, the stock market is a dynamic environment. It conforms to its contestants and their actions. Whatever inefficiency that has been found, will no longer be effective once enough people know about it. This means whatever you knew about the patterns become obsolete in just a few weeks and you now need to find a new one.
   
   Like Sisyphus, they are cursed to endlessly roll the immense boulder up the hill, only for it fall again and again.
   
   For example, on the 7^th of December, Sapura Energy fell 24.5 sen or 20.2% to 96.5 sen per share, and naturally, quite a few people started to buy, relying on their chart knowledge that there should be a technical rebound in price, possibly enabling them to earn a profit.
   
   Except it continued to fall 30 sen or another 31.2% over the next few days to low of 66.5 sen. For those who purchased this with the maximum margin (loan) of 3 times, they would have gotten margin called and lost it all. To top it off, as they would have been forced to sell, just before a rebound in price occurred on the 5^th of January, with the share price gaining 9.5 cent of 13.3%.
   
   So what’s the alternative?
   
   The alternative is to take an owners view, to look at shares as fractional ownership of a business. And therefore evaluate the purchase of our shares in much the same way we would evaluate a business for acquisition in its entirety.
   
   The main preference, would of course be a business in a fantastic industry, with a long-term competitive advantage (or “Competitive Moat”), operated by honest and competent people and most importantly available at a fair or very attractive price.
   
   During our project to read 5 years’ worth of annual reports for all 926 companies listed in the KLSE, we have found one, and it also happened to be available at a fair price. The other will of course be the one and only Public Bank (Do note a few more have since been found, but prices are not as attractive).
   
   The company’s name is XXXXX. In brief, it is the best in class provider of a service in Malaysia (offering 7-10x more value than their competitors), and they do it at the cheapest price. This business is also backed by a moat that ensures that it stays in that position. It is currently the largest holding of the fund at 28%.
   
   However, companies like XXXX don’t come often, and when they do, they are often very expensive, making it a bad investment. AMAZON for example, sells at a stratospheric 275 P/E, meaning, if one were to purchase it now, it would require 275 years in order to earn back the money you paid for it. Looking back to the beginning of modern history, I cannot even think of a single company founded 275 years ago that still exist today.
   
   The alternative, will be for us to invest in businesses that are in good (not fantastic) industries, managed by good people, and available at a very attractive price, such as Latitude, which if paid the current price now, would make it back in less than 2 and a half years.
   
   Or even business that are backed by incredible assets (such as land or property), such as Plenitude, Daiman or Oriental Berhad whose market prices equate to only 15-25% of the revalued net asset value, it’s like paying RM150,000 for a house in Subang worth RM650,000. How do these shares obtain such low prices? It’s simple, the price is low.
   
   If the price was high, people would have been buying it every day. Remember what I said about laws of economics being wonky in the stock market.
   
   At the end of the day, investments in stocks, is the long term arbitrage between the price and the intrinsic value of the stock. In the long term, prices will rise or fall to fair value. A simple case would be Hengyuan, it fell from RM9 in 2013 to RM2 in 2016. In 2017, it rose an incredible 800% to RM19.
   
   RM 1 cannot sell for RM0.5 forever, in the short term, it may even fall to RM0.1 (in which case, we should buy more). But in the long term, it should rise to somewhere near RM1.
   
   As Howard Marks always said, to succeed in investing you just need 3 things.
   
   1)       The ability to estimate the intrinsic value of an investment.
   2)       The ability to hold and buy more as prices fall.
   3)       To be right. (Which leads us to our next two principles).
    
2. To employ zero leverage.
   
   Leverage essentially means the use of borrowed money from the bank to purchase stocks.
   
   As the brokerages love to say, it allows one to super charge ones earnings (as long as you pay 5% interest, and a much higher transaction fee of RM24+0.15% of the transactions value per transaction).
   
   They often also conveniently forget to that it magnifies your losses. Often a brokerage will allow one to leverage up to 2 times your capital.
   
   This means a mere 10% gain, would enable you to make a 30% return. Conversely, it also means that drop higher than 33% would case you to go bankrupt.
   
   During the 2007-2009 crises, even the stock of the best managed and most trusted company in the world, Berkshire Hathaway (run by the one and only Warren Buffet), had the price of its shares fall almost 53% from USD148,220 per share to USD 73,195 per share. It now sells at USD300,000 per share. Google for example, fell from USD373 per share to USD131 per share, it now sells for USD1,111.
   
   Even the people who were only 1 times leveraged would have lost it all during the fall, and would have therefore missed out on the subsequent gains as they were forced to sell off their holdings previously.
   
   Like life, in investing, it is key that one always remembers the 6 foot tall man who drowned crossing a river 5 feet deep on average. It is not enough to survive on average, one must also survive the lows of investing and life.
   
   And as long as you do, given a long enough time and continuous improvement in decision making, you should end up doing very well for yourself.
   
   As the fund manager, I expect to maintain my long term equity positions, and may not sell the Fund’s investments even in times of extreme market volatility in the face of constant bad news, when general economic sentiment is depressed and negative, even if to the extreme.
   
   Even if this takes place over prolonged or extended periods of time; as long as the I, as the fund manager is of the view that the underlying business fundamentals of these investments have not changed.
   
   And only by employing zero leverage, can this be done.
    
3. Diversification.
   
   In this fund, we are not allowed to hold more than 30% of the fund (this may be reduced in the future), on a cost basis on a single investment. Why?
   
   At the end of the day, the real danger in life, is that you do not know, what you do not know.
   
   Warren Buffet have once said, “Diversification is protection against ignorance. It makes little sense if you know what you are doing.”
   
   And he is right. At this fund, the size of funds we allocate to a certain investment, correlates with our confidence in said investment, due to a deep understanding of the business and its value due to thorough research, coupled with a fantastic price.
   
   However, at the end of the day, it isn’t what you know that will kill you, but what you do not know. A certain concentration in your best investment is need to ensure superior returns, but a certain level of diversification is also needed to ensure that you survive in the event your thesis proves wrong (and statistically, this is inevitable, all you can do is limit your losses then).
    
4. Long Term Only
   
   As I have said earlier, at the end of the day, investing is about the long term arbitrage between the price and the intrinsic value of an investment.
   
   There is a saying I strongly abide with. “Time is the friend of a good investment or business, and the enemy of a bad one”.
   
   As you can see in the cases shown above, such as Hengyuan or even the 2008 crisis. One can never really know how prices will move over the short term. Yes, some people have predicted the financial crisis, but how many have predicted it’s consistently?
   
   We believe that, given time and patience, as well as a value focused mind-set to buy businesses or investments at 50 cents on the dollar (sounds weird to say 50 sen on the ringgit, doesn’t it), we will be able to obtain the superior returns that we aim for.

Closing statements.

While I will continue to attempt to raise new capital, it will not be my policy to compromise the Fund’s current policies and principles to do so. You have all accepted the fund on its own terms, and first and foremost, it is my intention to protect your capital and enhance your returns.

And for some of you who are IOU holders (Principle Guaranteed, with XX% guaranteed interest “Highest FD rate in Malaysia” and 40% of return above XX%), the protection of your principle and minimum profit is guaranteed.

Be assured that I eat my own cooking and have my own skin in game. The vast majority of my liquid net worth (99%), aside from money set aside for modest living expenses, is in the fund.

If I compound my own investment in the Fund at a rate of 15% annually, excluding fees, for 50 years, I will have over RM130 million. If I achieve 20%, I would be a billionaire with RM1.09 billion.

This is how I think about your investment. It is also why I do not think in terms of monthly or quarterly snapshots of performance, although I do understand that after 5 years or so, you would expect to see a favourable trend. I intend to provide it.

The current holdings of the fund on a percentage basis as at prevailing market prices is as follows:
 

The fund maintains a high degree of concentration, with the top 3 holdings comprising 60% of the fund. Some of these stocks may be relatively illiquid. As a result, apparent short-term may be adversely or positively affected by otherwise normal fluctuations in portfolio holdings.

While it has not been my observation that the Fund experiences undue volatility on a daily basis, there can be no certainty of this trend continuing. I do not view volatility as being in any manner a measure of risk, and hence the fund is not managed to minimize volatility.

Please feel free to call me if I have not been clear, or if you need further clarification on the matters discussed above.

Sincerely
Jon Choivo

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Facebook: Choivo Capital
Website: www.choivocapital.com
Email: choivocapital@gmail.com