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A
Well, hello, capital decanters. As we take a short break and a needed rest between season two and three, we're doing something a little bit different this year to highlight our key episodes. So given the sequence and the timing of when these episodes are released, as we thought more about it, because they drop across a period of 10 months almost, it's a bit unfair to simply take the quantitative number of downloads as that, of course, is going to arbitrarily advantage the first few episodes that have been available, of course, the longest. So this year we're going to combine a little bit of art and a little bit of science to highlight what we're calling the decanted half dozen. These are the six episodes that were the most influential and popular. And that's based, of course, on the pure stats, but also on what we're hearing around the industry about what topics are most timely and transformative. So here they are, season two's most influential and popular episodes. Coming in at number five of the decanted half dozen of season two was episode nine, China. Despite having one of the most ancient histories of any country in the world, modern China is, well, modern. The miraculous investment, economic and social story of today's China was only put into motion in the late 70s and 80s. So does this thesis still hold in today's delicate geopolitical environment? Is China investable? This is a critical episode for today's global investor and even citizen. Welcome to Capital Decanted. In this show, we say goodbye to tired market takes and superficial sound bites because here, instead of skimming the surface, we dive into the heart of capital allocation, striking the perfect balance and exposing the subtleties that reveal the topic's true essence. Prepare to have your perspectives challenged as we open up the issues that resonate with the hearts and minds of those shaping capital allocation. We've enlisted the wisdom of visionary leaders in the industry and just like a meticulously crafted wine, will allow their insights to breathe, unfurling their hidden depths and transforming our understanding. This is season two, episode nine of Capital Decanted. Is modern China investing for the intrepid or the foolhardy? I'm John Bowman.
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B
And I'm Aaron Filbeck.
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A
And we are your hosts. A huge thank you to our returning title sponsor, Alternatives by Franklin Templeton. We are so grateful to have them back to partner with us on this season two. They've got over 40 years of alt investing experience, over 260 billion of assets under management, and their specialist investment managers have expertise across six different asset classes. Asset classes that we cover a lot on this show. Real estate, private equity, private credit, hedged strategies, venture capital and digital assets. And of course, all of them operate with the client first mentality that has always defined Franklin Templeton to help prioritize investment outcomes. So thanks as always. Alternatives by Franklin Templeton well Aaron, here we go. China, this is a big one. I can say that as we'll talk about in a few moments. The prep was beastly. It was deep. We were talking in the green room, listeners, about the reality that this topic, maybe more than any we've done. Every time you think you know a little bit more, there's 15 more layers you have to peel back and uncover. So we'll give you a couple disclaimers about what we can't possibly promise and what we can't cover. But nonetheless, it's a big task. It's an exciting task and I hope you enjoy it. China, by all accounts is one of the oldest countries in the world. It is an ancient empire with a rich winding cultural history. It extends a few millennia, literally starting with the unification under the Han Dynasty. However, the People's Republic of China, and I'd suggest to you the modern post Mao form of the PRC is still in its infancy. We often say that America, with only 250 years of history, is still an experiment trying to find its way. But if that's true, then modern China by comparison is a toddler only 50 years old. And the Chinese will often refer to Xi Jinping as just the fifth generation of rulers since the Civil War ended in 1949. So if you accept the premise that this form or era of Chinese history began in 1976 with the death of communist revolutionary Mao Zedong and saw the rise of his multi decade lieutenant, but fundamentally different, which we'll get to Deng Xiaoping. The last five decades, at the risk of hyperbole, you could say arguably is the greatest accomplishment in human history. Way to drop some serious drama here in the first couple minutes of this episode, but just consider this. Over the course of that short period, annual GDP growth has averaged over 9%. Again. Many will question how accurate, how precise that is, but even if it rounds close, it is unbelievable to think about a stretch of that long Knocking on the door of double digit GNP growth. Deng took in his own words, a quote, backward closed, overly rigid socialist nation to a global power with a modernizing economy. End quote. So the structural changes that took place under Deng's leadership in less than 20 years and continued under his successors rank among the most transformative evolutions on the greatest number of people in the history of the world. Depending on the study, between 8 to 900 million people, that's 3Americas have been raised out of extreme poverty since the late 70s. This is by far the largest reduction in inequality in history. And that prosperity miracle went hand in hand with rapid urbanization. When Ma died, for example, again 1976, over 80% of the population was rural, illiterate, largely isolated from the world. And today about 2/3 of the 1.4 billion population live in urban city settings. And while there's still disparity, no doubt among the east and west of this massive country, literacy rates of school age kids is over 90%. Education levels are often lauded as some of the most rigorous in the world, particularly in the STEM areas. And as a result of all this, those that have invested during this period have been rewarded handsomely with startups becoming national champions and now global champions. Tencent Alibaba, Baidu, Huawei, BYD, JD ByteDance, my twin, just to name a few. These are names that are now recognizable by most that operate in consumer Internet businesses or investing generally. But the question, despite all of that we want to ask today is whether the music has stopped. Has the peak of this economic story run its course? Particularly has the political environment, particularly the market based policies, built on a foundation of pragmatism, reversed under Xi? And does the geopolitical tech and trade staredown, the decoupling between the US and China, introduce a structural governor, you might say, on the upside from here, as our title suggests, does investing in today's China still offer unparalleled exposure to this miracle story for the intrepid, those that are willing to face the volatility and uncertainty and even career risk of this unique market? Or is the risk simply too high to justify even the more optimistic return opportunities? That is our mighty task today. So blueprint for today is as follows. Here's where we're going I'm going to provide what I think is a critical piece of the puzzle for the investment thesis through the modern historical context since 1976. As I mentioned, and as I've already hinted, this is going to be focused mainly on this idea of a ballast pragmatism. Despite a whole lot of noisy news flow in the west, sometimes very real, sometimes exaggerated, sometimes just fear mongering, China bulls rest in the siren song, this magnetic pull of a pattern of leadership, particularly in crises or when economic times get tough, of reverting to what works and what is best for the population. So pragmatism has bested ideology as the signature policy since the late 70s. And I want to try to illustrate why that is essential through the previous few decades since again Mao's death and as you think about the future from here. And I want to attempt to equip you through that brief retrospective. And I say that carefully and humbly as I am no expert at all, but at least provide some techniques and objective evidence on both sides of the argument on which to evaluate Xi through this historical lens of pragmatism versus how his predecessors might have led. And then Aaron, in his part of this important background, he's going to dive a bit more into both the recent history and forward looking view of investing in China. He's going to focus on the evolution of China, opening up their capital markets to foreign investors, how asset owners and managers have approached China as an investment thesis and some of the risks and opportunities that investors will need to balance when considering whether this is an investable market. On top of this foundation of government pragmatism that I'll try to unpack. And after that hefty and challenging groundwork, we're going to invite our guest into studio. And today we are delighted to have Ed Grefenstedt, CEO and CIO of the $1.5 billion Dietrich foundation out of Pittsburgh, Pennsylvania. Dietrich foundation takes one of the most distinct counterintuitive approaches to asset allocation. I don't know about you Aaron, but I think that I've ever seen that the portfolio is 90% private markets. You heard that correctly. 9,09 out of 10% private markets. Nearly a third of that. One third of that is in China. Ed has taken nearly 50 trips to China over the years. And Bill Dietrich, the industrialist and founder of the charitable organization, in 97 after selling his business, which is where this liquidity event came from, he was a very early believer in China, begun investing in early stage private enterprise there in the mid 2000s. One of the first movers and Bill, and now his apprentice and CIO Ed have memorialized this in their investment philosophy. And I would call this approach their twin allergies towards two death knells for long term outsize returns. One is following the crowd, meaning conventional wisdom. And second and relatedly, career risks driving irrational risk aversion which leads to effectively closet indexing of the average portfolio. And one particularly prescient excerpt from their investment philosophy that I think really sets the stage for how to think about China reads as follows. Quote. In working to achieve the portfolio's long term growth objective, the greatest risk of all may be the periodic temptation to take no risk at all. Risk in all of its many forms, is inseparable from the investment process. Both investment theory and practice demonstrate that without an investor's willingness to assume risk, there can be no possibility of return. Our approach to risk management will include both quantitative and qualitative elements as a result. Now, Aaron, obviously, theoretically, we all assent to that, but I think when you put this in practice, career risk, indigestion, fear of the conversation that will occur with the board often takes precedence. So I think Ed and Bill before him lay out a really important warning on what human nature does once you attempt to put this risk, return, balance and connection into practice. So we'll talk a lot about that today. And that bold swimming upstream, ignoring the herd mentality, whatever you want to call it, particularly in China, has paid off big time for them. That is a technical phrase, big time. The Dietrich foundation uses a peer group of university endowments, US University endowments, in return benchmarking with their board, and they use Cambridge data, both at the full universe level and the subset of endowments that are over a billion US of A. So over a 20 and 10 year period, the peer group, meaning greater than 1 billion, has median annualized returns of 7.7 and 7.4% respectively. Again, 20 and 10. The Dietrich foundation, on the other hand, reports 11.4 and 11.2 annually over that same time period, putting them solidly, of course, in the top position for both periods. Now, not only did they smoke the median by several hundred basis points, just doing the math there, but that's 70 basis points over the number two for the 20 year period, which was MIT, by the way, and 40 basis points over number two for the 10 year period, which was Brown. It just ain't that close, folks. They are spanking the top endowments at their own gain. And a big part of that is today's conversation of China. So, Aaron, I want to start with a question for you. We talked a bit beforehand, our prep. I know you've never been to China, but before this research, obviously you talked to a lot of investors, talked to a lot of clients in your previous world. What do you think was your worldview impression of investability of China?
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Yeah, it's a really good question. I think that when I look back, even 10 years ago, and I think that view has evolved over the past five years, but I would say that there's a lot of trepidation in China. I think the political news and headlines that we've seen, especially since COVID have caused negative sentiment when looking at China as an investable asset. And I do think that a lot of the narrative that's being spun here in the Western media makes it challenging to spin a positive story. And in fact, we'll get to this later in my segment, John, I actually had to actively go out and talk to people about the positives of investing because when you look up any news article and reputable sources could be the ft, the Wall Street Journal, there's a lot of hair in this particular area of the world. So I would say that coming in, my bias was this is a really challenging market. My view is probably a little bit more nuanced moving forward. There's still some challenges, but there's a lot of opportunity as well. So how about yourself? I mean, I know you've been. But what's your view pre this episode versus now, having gone through the whole history?
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Well, I think you're right that to use Ed's term for what you just described, the conventional wisdom is a massive headwind if you're in the west to craft with any level of intellectual conviction a bullish story. That's why those that have been courageous and done the research and done the hard work, I think it's paid off so handsomely. So I think because I've been there and spent a lot of time in Asia through the course of my career, the two worlds of media spin, to use your word, are familiar and understood and I can sift my way through it. But look, when you're sitting, as I am now in the us the new slow overwhelmingly is going to paint one picture. And if you go to other parts of the world, it's going to paint a completely different picture. So you just have to be discerning and objective, which is again, maybe a good segue to the reason we created this show. And certainly our goal today is tough as that might be for two Americans. But we're going to try our best. So I called this episode with that in mind a mighty task. Aaron, a few minutes ago, which is a massive understatement. These episodes typically take me. I don't speak for you, but I think I've guessed about 20 hours of reading and note taking to prepare for the normal episode. I would say I've at least doubled that on this particular episode. Both page count and my preparation of reading and writing this was by far the most taxing prep work to date. Taxing not negatively, but just laborious in many ways. But I loved it. More importantly, it was necessary to be credible at all, which I hope we can dance at least on the line of credibility over the course of this period. But the Chinese investment ecosystem demands you peel back layers of complexity. I think we talked about this at the very beginning. Emotion, I think, and frankly, naitivity. The Chinese economic and political system, which is intimately intertwined, is like one of those Russian nesting dolls. Matrushkas, I think they're called, where just when you think you've gotten to the root or the core of the issue, the smallest doll in the nesting set, there is another trail, another tentacle that further complicates the issue that you need to chase and explore. Or just say, look, I can't possibly go any farther, which there were moments like that in the last couple weeks too.
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B
Maybe I can co sign your prep. So for the listener's benefit, I think maybe the past four or five weekends I've gotten a text from you with a picture of the book that you've been reading, which I know is a monster, but what a way to spend your Friday night. So dedication to the podcast. Well done.
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A
Nerding out my weekends have not been as enjoyable as they've been previously, but I did enjoy it. I'll get to that book citation in a little bit. But you're right, that was a beast. Beast of burden. So before I try to talk through these layers, I mentioned that I had a few disclaimers, and I think I speak for Aaron on all of these, on how we're going to approach this episode. So first, while history, particularly recent history in China, as I'll further explain, is critical, you need to forgive our misreads, our leaps, our gaps. We are not historians. I've been to China several times, as I just mentioned, on business. We have an adopted son from the Hebei Province, which is about 200 miles south of Beijing, just geographically. But I am far from an authority here. As I mentioned, and as Aaron just teased me, I read a lot of background material. But my main historical source came from Ezra Vogel's 2011 book, which was called Deng Xiaoping and the Transformation of China. And by the way, this was Ed Grefenstedt's top recommendation. When I asked him for some advice, he said, if you read any book on modern China and how it impacts the investment thesis, it's that one. Vogel's tome was 900 pages. This was backbreaking weight in my Carry On. It was an absolute masterpiece. But let's just say this book, I think, deserves premier mileage status on United at this point, it's itself, it certainly got around. Second, and possibly somewhat more controversial. If you're looking for Aaron and I to moralize on either the socialist versus a capitalistic form of government or the integrity, the quality of the leadership of the ccb, you're going to be disappointed. We are going to address some concerns as it relates to centralization of power, rolling back of freedoms and how that might impact private enterprise returns. But frankly, we're in no position to argue moral high ground, nor is it the purpose of this episode. So it's not that Aaron and I don't have principles and our own personal moral compass, but we're going to discipline ourselves to not apply or render those judgments on the investment opportunity here. So I hope that's understandable. And third, maybe most obvious, this is going to be long, so buckle up, get a snack. We're in record breaking territory. Aaron, last episode was the shortest episode to date, so it is only natural that I can predict with almost certainty that what we're about to embark on is likely going to be our longest episode.
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What a privilege for everyone to listen this topic.
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We talked a lot about this, listeners. I think it was inevitable and necessary. So I hope you agree after bearing with us. So I'd encourage all of you to do somewhat of the same in approaching this with objectivity. Back to my second disclaimer. At the risk of sermonizing here, one warning when approaching a place like China, if you grew up in the US or anywhere developed Europe, is owning that we are loaded with baggage and a worldview that forces a particular lens and then is perpetuated by the media and by all types of publications. Some of that lens, in this case might be virtuous or helpful, but other parts of it will inevitably inhibit your ability, as I said, to be objective, to see opportunities when the conventional wisdom, again, there's that phrase suggests that you should run away. So as we always attempt to on the show, we want to try our best to assess the situation with some intellectual honesty and balance. Even Margaret Thatcher, the Iron lady herself, recalling her first visit to China, admitted having to work at shedding her own bias after almost a year of stubborn negotiations over returning Hong Kong back to China. In the early 80s, when she first visited, she famously channeled an old Chinese maximum saying, quote, seeing for oneself is a hundred times better than hearing from others. End quote. So China cannot be studied, it needs to be experienced. So let's try to emulate that here on this journey together. All right, Aaron, so brief history, 50 years of history in the broader scheme of Things. This is just a minute, but I need us to go on a journey together to build a case for pragmatism or not, as you think about she and as you think about your opportunity in investing in China. So as I mentioned earlier, and I'm breezing through as you're going to see thousands of years here, but as most of you know, China was under dynastic rule for over 2000 years to the end of 1911 when most of the imperial world and order was crumbling. And in this case the Qing Dynasty, the last Chinese emperor, fell to revolutionaries, creating the Republic of China. Now, this chapter of Chinese history was short lived. I don't think it's well covered for obvious reasons you'll pick up on. But it was also massively fragmented. The leadership as other than a short intermission when the two or even multiple sides, depending on how you define sides, they joined forces to battle the Japanese during World War II. But other than that short interlude, the Republic was in a constant state of civil war with buying factions and warlords and power plays across the country. So it was complete chaos for a few decades. And then in 1949, the CCP, the Communist Party of China's Red army under the leadership of Mao Zedong, defeated the Nationalists and they fled to Taiwan to establish rule there. And hence begins the awkward dance of one country, two system between the mainland and Taiwan that of course continues to this day. Now, Mao is a controversial figure, again an understatement, this episode even amongst Chinese people. He is a controversial figure in his nearly 30 years of leadership because on the one hand he liberated the country from imperialist rule, he opened relations with the US under the Nixon administration, he established this five year planning cycle called Party Congresses that has created a lot of long term strategic capability for China versus some of the short termism that exists in hyper democratic countries like the US and beginning, or perhaps better said, he tolerated the beginning of market reforms. On the other hand, Mao, as we're probably more familiar with in the west, oversaw the Great Leap Forward, the Cultural Revolution in the late 50s and 60s that resulted in mass starvation, persecution, exile and even in some case death of the privileged elite. This was class warfare directly out of Marxism. And Mao died of a heart attack in 1976, which eventually led to Deng Xiaoping, again his lieutenant, assuming ultimate leadership of the country. And he led from 78 to 2002. And this is where our story really begins to take shape when Deng assumed leadership. This period of Chinese history is very relevant to today's question of the day, even though it is still in its relatively short early stage. So Deng oversaw the CCP from what you would call a revolutionary party under Mao to a governing party. And while he remained loyal and defended many of the underpinnings of Marxism, Maoism and communism broadly to his death, he abandoned this ideological zealotry, you might say, of Mao, and replaced it with much more of a practical framework for decision making and policy establishment. He was often called a die hard pragmatist. So there it is again, pragmatism. Deng was never concerned about orthodoxy, but simply what worked. As he would say, as he famously declared, quote, it does not matter if the cat is black or white, as long as it catches the mouse, end quote. So in other words, China no longer needed to adhere rigidly to to the ideology of the Maoist era, but rather adopt a culture of trial and error. His philosophy of governance was one of experimentation, you might say small, isolated petri dishes of innovation where he could test ideas. And if it worked, he would broaden consensus, he would move the goalposts a bit more and then rinse and repeat. So he once said, quote, don't argue it, try it. If it works, let it spread, end quote. And another one was, quote, I'll go my way, you go yours, and let's see what works, end quote. So again, incubate, push, spread was his MO and nowhere was this experimentation more apparent than Deng's obsession with carefully introducing market forces into the Chinese economy. It was a constant tension, as it still is, a tug of war that needed calibration. There would be acceleration, deceleration, and it completely defined his tenure and identity in leadership. Deng termed this socialism with Chinese characteristics was his phrase for this combination. He never lost belief in centralized power or centralized planning. I think actually it's one of the big mistakes of history, particularly driven by the west, is to claim that Deng was this capitalist at heart that was just buying his time until he could convert and bring down the Communist Party. It was quite the contrary. He saw separation of powers in the west being the legislative, the judiciary and executive branches as inefficient, as overly short term. Deng wanted no confusion about who was in charge. And democratic shared leadership, he believed, also resulted in gridlock that would foment policy paralysis, discontent among the masses. He may not be that off, frankly, in modern times on that one, but nonetheless he was no democratic believer. But he was also convinced that China needed to evolve. He often warned of the Soviets lack of introducing market forces, importing best practices of technology and modern management techniques. From the west and Japan as the main source of the collapse of communism in Eastern Europe. And he did not want to follow in that path. There was a paranoia that hung over China when thinking about what happened in the fall of Soviet communism in the late 80s. So he knew that if central planning and control were to sustain themselves long term, he would have to ensure the masses were participating. They were benefiting from the transformation of the country. So he had this keen eye on the reality that crush the Soviet empire, as I just mentioned, which was revolution and collapse would eventually happen to them too, if the leadership failed the public too long. Deng realized, unlike Mao, that the wishes of the people, regardless of temporal government structure, would ultimately prevail, and he needed to play to that. So he got to work with a grand plan to turn this backward agrarian nation that had largely missed the industrial revolution into a modern, advanced society on the world stage. And he prioritized four modernizations across science and technology, industry, military and agriculture, with the goal, just shockingly, to quadruple GMP between 1980 and 2000, so to double GNP twice in 20 years. Just shocking. And in doing so, he basically imported an industrial revolution, an informational revolution, and a consumer revolution all at once. Again, I can't say this more boldly, but it was a true modern miracle. And all this was done with the delicate balancing act of pragmatism. As I've said, it's this uncomfortable but symbiotic relationship between central planning on the one hand, and market accountability on the other. The state regulated and determined the guardrails of the market, but then the market's freedom would guide private enterprise. And Deng knew that over time, the role of central planning would gradually move to more of, you might say, a capital allocator role, as the markets would have more freedom to flex, to demand, to consumer preferences, to foreign trade, et cetera. Now, this strange harmony, as we get practical here from philosophical, would be the most notable and probably most broadly displayed, as Deng created four special economic zones, or stages, EZs in the south of the country that had much more capitalistic freedom to develop their micro economies. Again started as a laboratory. And by the way, Aaron, do you know who was the architect, to stump you here, of those first SEZs down in the Guangdong province?
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I have no idea.
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You didn't pick this up in the research. A strange connection of dots here. That would be Xi Jinping's father, if you can believe it, who was the party secretary of the province when Deng began introducing those reforms. So he was a Liberal reformer Xi's dad. So we'll get to Xi momentarily. But he saw as a very young boy the power of market forces and pragmatism playing out in the south. So in the spirit of trying things out and expanding once it works. After Deng's famous Southern journey in 1992, just as he was retiring, he broadened the SEZ model to over 50 special economic cities and zones and free trade areas along the southern and eastern coasts. As the evidence of this progress began to progress and get clear. So pragmatism was in effect for the SEZs. It was also in effect for other examples, like ending collectivized agriculture under MA and moving the household level farming responsibility and incentives to the household, privatizing effectively to individual farms, introducing liberty for small private businesses, which he started with food stalls and allowing hybrid pricing for state owned enterprises. And so slowly but surely introducing these capitalistic techniques now, as he moved to hand off power to jiang Zemin in 2002, Deng solidified this idea of pragmatism into the very DNA of the Communist Party of the CCP. And this is important culturally. So just bear with me here. Just as Mao Zedong theory, which is actual a thing, it's a phrase that is cited often within the Politburo of the leadership of the Communist Party. It was a guiding rule book post Mao for policymaking for decades. Again, in that was this idea of class struggle, revolution against the bourgeois, the imperialists. And Deng understood that he also needed ideological justification for adopting these pragmatic policies that supported and continued expansion of markets. And if the four modernizations, as I mentioned in this new type of revolution, economic revolution, were to stand the test of time, it needed its own identity. And so was born and memorialized Deng Xiaoping theory. Deng Xiaoping theory is also a thing, parts of which even made it into the constitution of China. And as I said, this was a really important step for the culture of Chinese leadership as a way to ensure resonance with the public and staying power with the leadership over this living tension of central planning and markets. And Zhang, as he took over, relied on Deng's theory, often during the leadership transition, for his new phraseology. So Deng's socialism with Chinese characteristics would eventually morph into Zhang's quote, socialist market economy. So starting to press in a little bit more with more explicit language. And in it, Zhang emphasized that China needed to continue taking lessons from the advanced practices of the capitalist countries. And in fact, importantly, this was really an interesting tidbit that should not be overlooked. Jiang said that there was no longer need to discuss or debate whether these reforms, particular reforms, were capitalistic or socialist. So often there would be this debate about whether they wanted to experiment with something and they would say, oh well, that's not socialistic, that's capitalistic. We can't do that. And Zhang argued that these definitions and arbitrary categories no longer mattered. Planning was not the same as socialism, and markets were not always the same as capitalism. There was a hybrid here that we could live in. Okay, so why am I belaboring all this recent history, particularly Deng Xiaoping's reform agenda? Because it's critical to understand that that long shadow of pragmatism that Deng pioneered and cast over the party has been the working model and as I said earlier, the ballast for this country for nearly 50 years. So if you were going to get your head around investing in China, particularly in locking up capital in private markets over the long term, your confidence and pragmatism of the CCP must be the foundational start. And you must have a view that it is durable. It's enduring under Xi, just as it was durable and enduring under his predecessors. Here was Bill Dietrich on the risk of getting caught up in sentiment and short termism when assessing China. He said, quote, you can't invest in China venture capital without tolerating sharp up and downs in sentiment. Just remember, when things look sharply up in China, conditions are never as good as they appear. And when things look sharply down, things are never as bad as they appear. But over time, most things are trending upward. Sounds like pragmatism. The economic cycle, the fundamentals, geopolitical and trade relationships, some of the things you're going to cover in a bit, Aaron. Of course that's all important. You got to do your homework there. But all of that is trumped, no pun intended. All that is trumped in a centralized socialist government, by your belief or not, for that matter, of whether Deng Xiaoping theory still rules the day. So as we shift to Xi with this backdrop and a more informed map of what to look for, your first task in answering this question decanters is whether Xi represents a departure from previous leadership back towards, you might say, ideological orthodoxy, or whether ultimately practicality will continue ruling the day. Those constraints will push hard against even she's preferences. Now, again, I want to be clear here. I'm not going to lend meritorious or normative judgment on whether Xi's policies or decisions are good or bad. Obviously I have my own personal views based on my own personal values, as I said earlier. But the point here is not to define whether Xi's approach is right or wrong, but rather simply if it's consistent with an eye towards moving at a pace the public will still condone, and a balance of ensuring that, in his own words, Xi's own words, common prosperity and economic participation will continue to occur. So I want to attempt to assess Xi on this basis of pragmatism briefly, before I hand it to you, Aaron, through four topics, four topics that are talked about quite often. Those are centralization of power, two, private enterprise, three, the surveillance state, and four, foreign policy. Just as I finish my segment here. So a negative turn, of course for one or more of these would be a big concern, that the socialist market economy of the last five decades is at risk and the basis by which you have invested probably needs reevaluation. Okay, so just cycling through these centralization of power. So after Mao's death, while certainly Deng was the ultimate decision maker, there was no doubt about that he worked hard to transition to what he called collective leadership and consensus building. So for example, he introduced term limits, he introduced mandatory retirement ages, he delegated much more broadly behind his loyal insight circle to simply who was best for the job. And he welcomed diversity of input, what he called a hundred flowers blooming across the party leadership. And all of this was designed to remove the over concentration of power, to check dictatorial power, at least to a degree, and to avoid the personality cult of Mao that had even caused Deng and his own family some pain and challenges. And Jang, again the successor to Deng in the same vein, called himself a first among equals, continuing that process of shared leadership. So probably the biggest red flag from those concerned about Xi's leadership is his reconcentration of power, at least on paper. Xi holds all three major positions that Deng had previously separated and used as pathways, intentional pathways for succession and leadership development. Those three most important positions are General Secretary of the party, which is the most important, the President. And then thirdly, the head of the Central Military Commission or the CMC. And at the 20th Party Congress in late 2002, famously she did away with the two term limit on the presidency, which saw him elected for an unprecedented third five year term. And he demanded much more loyalty pledges to the party and his leadership of the 24 seat Politburo, even reintroducing public self criticism, which was a Mao thing, to ensure allegiance and loyalty. Now Aaron, I might offend listeners here, but personally having researched this a bit, I think all this is a bit of a nothing burger or massively exaggerated on paper. So first of all, the President was the only position of the three to previously have had term limits, so the General Secretary and the head of the CMC did not. And frankly, if anything, the President was the most symbolic, meaning the least important of the three historically and further culturally. While Deng himself only had the CMC title, he had delegated, as I said earlier, the other two titles. Both Zhang and Hugh held all three positions as well, just like she. So this is a precedent that she is frankly not breaking. He just seems to be continuing pressing in a little bit more. No doubt. But this is not a massive exception. So that's centralization power. How about view of private enterprise? All of us can name anecdotes of potential signs Aaron, I know you're going to unpack this a bit further that the Xi regime is moving away from favoring and relying on private enterprise. Well, whether it was the last minute block of ant's ipo, the fintech giant, the subsequent strange disappearance from the public eye of founder of both Alibaba and ant, Jack Ma, or the strong current of delistings of Chinese companies in Hong Kong and the West. And by the way, the market has unequivocally expressed distaste for these winds of change, particularly the technology sector. And I fully understand this approach, this opinion. The public markets have spoken. However, these moves may, and I stress may be some combination of misinterpreted or perhaps poorly communicated changes by the government. So our forthcoming guest Ed Grefenstedt, for example, stated in an interview with NMS Management, this is a newsletter. I'd never read this, but this is a newsletter for the E and F community on the subject. And Ed said the following quote Looking objectively past the headlines and near term market reaction, one sees that many of the China regulations are actually targeted and purposeful. They do not pretend a complete abandonment of private market principles. Many of Beijing's moves instead appear designed to address critical structural or social issues like growing income inequality and harmful monopolistic behavior. Issues that are in fact at the heart of much rhetoric and proposed legislation in Washington D.C. brussels and elsewhere. There is a big difference, to be sure. China's regulators are taking swifter, more radical action than their peers in the west to achieve again common prosperity and a more harmonious society. Ed continues, but our confidence in the market based principles continuing is anchored in the core belief that China's leadership is ultimately aligned with interests with foreign investors. Beijing acutely understands that for now its country needs desperately to attract substantial long term patient foreign capital and second, nurture the important innovation that foreign capital fuels via China's venture capital ecosystem. So simply put, there is no attractive, perhaps even conceivable alternative scenario where China's economic growth, developmental security and ultimately societal prosperity can persist without considerable inflows of foreign capital. So she gets it. And I think Ed believes that a lot of this is perhaps overdue adjustments to the private sector. Perhaps getting out of calibration is maybe the way the Chinese party would put it. Just a couple months ago this February, she hosted some of the largest tech CEOs in Beijing for a summit in order, in Xi's words, directly to promote a healthy and high quality private sector. CEOs from Huawei, Deepseek, BYD and even Jack Ma, interestingly were in attendance. And to Xi's credit, while Internet services and E commerce have been the previous decade's tech winners, a combination of fiscal stimulus and satisfaction incentives, government support from that recent five Year plan have also built true Chinese centers of excellence in EVs, lithium batteries, solar panels, smartphones, biotech, life sciences, semiconductors and AI amongst others. They are crushing it across the industry and tech world. Now does all of this portend a philosophical shift back towards private enterprise favoritism or simply the constraint and pull of pragmatism to re energize what is frankly a debt burdened economy that is flirting with deflation while attempting to digest a property collapse? I don't know, I'm not inside Xi's head whether it's a pure change of heart on his part or a reflexive shift back to more market driven policies to ensure consumer confidence and that all important mandate with this public I suppose my point Aaron is I don't think it matters. They seem to be continuing, nurturing and investing in the new economy and I don't think we should be surprised to see more what we've called Sputnik moments following on the heels of deep seek going forward. So third Surveillance state so that centralization of power in the private enterprise surveillance state. Jeffrey Wasserstrom, who's a writer and historian. That's a mouthful. Forgive me Jeff for your last name, pronunciation, writer and historian of modern China was on the Lex Friedman podcast about a week ago. This is mid April 25th and some of this I owe to this excellent segment. He had this conversation with Lex so on this idea of censorship, it's important to understand that if you haven't been to China this is back to Margaret Thatcher's position. You might have this image of Orwell's 1984 where everyone is in These monochrome clothes, pajamas looking melancholy under the watchful eye of cameras and Big Brother wherever they go. It is not that way at all. If you go to China, it's much more like Huxley's dystopian Brave New World where they use distraction and plain to pleasures and where censorship is mainly exercised through what scholars call friction. It's like an inconvenience tax on finding what you want to find online. Now most of us will know that Google, YouTube, Facebook, Wikipedia, Instagram, Reddit, X LinkedIn and others are all blocked. However, savvy Chinese can get around this on their VPNs, but that takes some level of sophistication. Certainly when I'm there it drives me crazy because I can't get into any of this, even in western hotels. But you need to update that VPN and reprogram it as I understand it, pretty regularly for this to work. So Wasserstrom quoted another journalist that said China has both the best and the worst online experience in the world. They have Chinese versions that are often better than anything we have in the west in E commerce, geo tracking, social media, etc. But it is frankly back to the dial up age if you want to use the western sites. And this bifurcation is very intentional. But this system, I should also say is porous. Most of the Chinese I've met are certainly careful, but they're free, they're independent, they're curious thinkers. This is not repressed intellectual curiosity. I think we also have to remember that what Xi is dealing with in social media, smartphones, artificial intelligence, video apps is far beyond what Deng or frankly any of Xi's predecessors had to face, this is not comparable. So if you have a very strong singular view of what the identity of China, and particularly the Communist Party history, identity and culture should look like, like she does, then the state of play is much more complicated to control. Now that is not me expressing empathy for where they've landed. It's just logical caution in how to think about this. And by the way, and this is one of my other advertisements, so sermonizing again Aaron, but I think we Americans need to be careful here to be overly judgmental. I for one am not in the camp, I don't know about you of the other extreme that unfettered free speech is healthy either. I mean as we've seen in more recent history, leads to not only what we call fake news, but I think more strikingly hate speech, discrimination, violence, to me that's just as dangerous. And our debates on Capitol Hill with big Tech are addressing this very same issue. We're having this very same debate. So we're going to end up in very different places. But this is a very complicated conundrum in a world where information is ubiquitous. All that said, there is no doubt that Xi has expanded mass surveillance through cameras, Internet, other digital tracking capabilities. Hong Kong, prior to the protests of 2016 and 19, had been a safe haven for criticizing the party, publishing objective books and articles, and even I would say, exercising kind of an arm's length independence and governance and the judiciary. But Beijing has really reigned that in and taken some significant steps to limit freedoms, particularly post Covid. So in pragmatism, the social contract seems to be as long as I give you lots of choices, a quality lifestyle and improving prosperity, you in return will tolerate some of these inconveniences. And so I think the question here is we'll see how this new generation assesses this pact, this deal going forward. Okay, Aaron, final stretch here, I promise. Lastly, fourth, foreign policy. So ironically, Deng had this quote I stumbled upon that was just almost laughable. He said, quote, china would never become a tyrant and that if it ever did oppress and exploit other nations, the world and especially developing countries should expose China as a socialist, imperialist country and in cooperation with the Chinese people, overthrow the Chinese government. I doubt that Xi is parroting that dang quote much these days. But Deng, and to follow him, Jang and Hu largely as well, they pursued a very deferential approach to foreign policy. They normalized relationships, Deng in particular with the US, with Japan, South Korea, Russia, Singapore, UK and others. They joined the United nations in 1971. They joined the World Trade Organization in 2001. It was soft power, it was gentle diplomacy. But early in the modernization project, we talked about a little China badly needed help with foreign investment, science and technology skills, education, manufacturing expertise, management acumen. It was a bit of required open handed deference that they had to take. They call it panda diplomacy. So they had no choice in these early days. And to be fair, we're in a completely different world now. Xi leads the second largest economy in the world, the pla. Their military is the largest in the world, certainly one of the most technologically advanced. Their private enterprise science and technology capabilities are unparalleled. Their educational system is excellent, perhaps the best in the world. So I would say further, I think it's important to understand that the cultural scars of foreign policy that still embody how the Chinese think, particularly the leaders of the Communist Party think about their relationships on the world stage. And this is really important because they had to suppress this for the first 20 years of this modern China modernization. But the Chinese will often call the period between the mid 19th century up to the communist taking power in 1949, those hundred years, as the century of humiliation. And frankly, that's for good reason. The two opium wars culturally were destructive. They led to huge national embarrassment as the imperialists carved up pieces of China. So the Brits took Hong Kong and the New Territories, the Portuguese took Macau, Japan took Taiwan in the late 19th century. Xi is really the first paramount leader that has the economic and military might to exercise power in this new world order. So I think some of the bravado and the wolf diplomacy, as it's now called in the South China Sea, the Indian border, certainly Hong Kong action, Taiwan rhetoric, is finally projecting a proud, strong history that was lacking for a couple centuries that Deng and Jang and Hu frankly didn't have the ability to project. Now Xi's centerpiece foreign policy effort again, Aaron, I know you're going to touch on this. And the best illustration of this new assertive leadership role in global affairs is of course the Belt and Road Initiative, sometimes referred to as the New Silk Road, which it's a global infrastructure development strategy that she really adopted in 2013 to invest more in 150 countries across Central Asia, Africa and Europe. And let's not be fooled, this is sometimes referred to as debt diplomacy or checkbook diplomacy. Is there's no doubt that a ulterior motive of this is that China aims to cultivate allegiance and dependence beyond infrastructure investments. But it certainly suggests Xi's vision to be a player around the world going forward. So they are exercising much more power and what does that mean for pragmatism and relationships? And we're seeing that live and in full Technicolor in this trade war with Donald Trump. So there you have it. Aaron, if you haven't fallen asleep, listeners, this calculus is not easy. Is Xi abandoning pragmatism or simply applying it differently, giving the modern and more the developed tool set that he has at his disposal versus those leaders that preceded him. So you're going to need to decide that for yourself. But I'd reinforce again that your investment thesis must largely depend on your view here before you get to any of the economic and fundamentals. It has to be born out of this belief or not in pragmatism. So, Aaron, I humbly hand to you after that short but long winded history.
- [47:49]
B
That was great, John, and trying to summarize what I know is a ton of research is a difficult task, but I think you did a good job. I learned a lot just in a short amount of time. So thanks for walking through that. Maybe just a question for you before I go, but you mentioned there at the end the whole pride around Chinese history and GE really trying to put forth this bravado. From what I understand, and maybe you can correct me, but it seems like they're much less concerned about expansion than you might see from other countries. We've talked about Russia trying to expand their territories and we've seen here in the US Even with Trump and some of the things that he's trying to do. Do you get the sense that there's a desire for expansion or is it much more focused on the home country?
- [48:31]
A
My understanding in research is that culturally through Confucianism and communism, Marxism, Maoism and even Dengism, all of those synergistic theories combined that the Chinese have never been expansionists. Now remember they particularly the Communist Party was revolting against imperialistic tendencies. They wanted an egalitarian, equal class society. Now again, they were terribly unsuccessful NER Mao's approach to that. But the reality is I think they're much more focused on again as I said earlier, that singular identity and unification of what they deem to be the Chinese nation. She is more nationalistic than I think previous leaders, but I don't think any of them have delusions of grandeur to be exercising power through military force with the exception of this one country, two system dangling issues that have been on their radar for 150 years as I just explained. So that's the best I could do in assessing that. Very good question.
- [49:33]
B
Okay, everyone like John, I'm going to preface my section here and just mention that I am not an expert on China by any means. I know many of you were probably thinking that I am, but unlike John, did not go through the process of reading a 700 page tome on China's history and in fact learned a lot just from some of the stuff that he walked through over the past several minutes. When I get into my section, I'm going to talk about three different things as I was thinking through the thesis and the evolution of China today and the capital markets system and the thesis for investing in it. Looking forward, it really comes down to three different groups and categories that I think are important to walk through. So I'm going to walk through the more recent evolution of accessing China. John obviously went through a much longer history of China, the government politics and policies. I'm going to focus much more on the capital markets side over the past 20 to 25 years. So that's section number one. I'm also going to walk through the historical and current sentiment of sentiment and commitments from investors. So that can be both on the GP side and the LP side. I think it's important to talk through how allocators are viewing things and then how different gps are viewing things. And then I'm going to end with more of a forward looking case for China. I'll talk about some of the opportunities and also talk about some of the risks as well. So on the first point, let's talk about accessing China from a capital markets perspective. And I think the main point to take away from this part of the discussion, there's two things I want you to take away. One is what we know today and what we experience today as investors really came about in recent history. What I'm going to walk through in the timeline isn't that old. So we don't have a long history of Chinese capital markets from an external and outsiders perspective. And then two, I think this evolution that I'm going to walk through ties into some of that pragmatism that John talked about and I think is an important point to underscore because we've gone from maybe a much more centralized way of viewing the markets locally to much more of a capitalism capitalist type of view of accessing these markets. So to do this you have to talk about both the public and the private markets in parallel, because they started at different times, but today they are somewhat close to the same place, at least in principle. So the public markets as we know them today really began their opening in early 2000s, so early 2002. Private markets started a little bit later in 2010. So we have an even shorter timeline to talk about in the private markets. So let's start with each of these and then we'll summarize a little bit the commonalities between both of those different markets. So the public markets started off very restrictive. So they did open up to foreign investors, to institutional investors who wanted to access local markets. But there were a lot of rules and regulations in place in order to do so. This really started with the Qualified Foreign Institutional Investor policy in 2002, and there were lots of variations that came later from that. You had the Shanghai Hong Kong Stock Connect in 2016, the Bond Connect in 2017. So different evolutions over the course of public markets, going from what they were pre 2002 to what they are today. But the idea behind this and all the different rules and regulations and quotas that were in place was the idea of slightly slowly opening up capital markets with a lot of parameters and guardrails in place. So as I mentioned, there were a lot of quotas limits in place in terms of how much you could own of companies domestically and how much you could actually invest in to the market. So for example, if I was an institutional investor and I wanted to access the China markets, I'd have a limit on how much I could commit to the entire market overall. And I'd also have limits on how much I could own of one particular company that I was investing in. So you had a really maneuver and finagle your way into this market. Now this was raised incrementally, these limits, these quotas were raised as more investors moved in, as the governments became much more comfortable with accessing these local markets. And eventually in the late 2010s a lot of this was done away with. So today we don't have these restrictions in place. But I think it's important just to show that evolution over time. The big moment in public markets came in the late 2010s and this is when we saw a shares, so domestic companies that were in mainland China being included in some of the major indices. So msci for example, brought in a shares as part of their overall emerging market indices, their Chinese indices. And this is important because what it allowed for was one, an acceptance into the global market ecosystem. But also because we've seen such a rise in index based products, ETFs who are tracking these indices, it allowed a lot of flows to move into the market. So this was a big moment, especially in the equity market. Now more recently we've seen continued build out of different platforms to support fixed income securities, derivatives and other vehicles, which has just led to this market becoming much more accessible to a lot of foreign investors. So a lot of the things that I just walked through, we take it for granted as U.S. investors. For us, if we want to invest domestically, it's very much a point and click. Even other parts of the world, if we're investing in parts of Europe, you want to buy an ETF for individual shares, you're able to do so with some level of ease. But this was not the case early on in the public markets for China. Now on the private markets, there was a similar trajectory in place. Now this started a little bit later, again, 2010 versus 2002. And it all began with the Qualified Foreign Limited Partner program. And this basically allowed investors to access onshore private companies from outside of mainland China. So before this, investors who wanted to invest in this ecosystem had to do things through, let's say a Cayman fund or other offshore solutions in place. But this was really the beginning of allowing GPS to set up shop and invest in those private companies. What's also interesting about this was that this was also restrictive. So despite it starting later than the public markets, it only started in certain areas of China. So originally started in Shanghai, but it was later expanded into other parts of the country like Beijing and Shenzhen. So later the rules went the other way. So a lot of what I've just talked about is these foreign investors who wanted to access Chinese markets, but there were restrictions in place for Chinese investors who wanted to invest outside of China. So in 2013 there were rules that were put in place and regulations that allowed for Chinese GPs and LPs to invest outside of China. So this was really the first time that you had a two way capital market system in the private markets. Now, more recently, the big concern in question has been exits and actually monetizing your portfolio companies. Remember, capital inflows only picked up about 10 years ago. So if you're investing in venture capital or private equity strategies, we're now right at the point where you might be exiting or trying to monetize a lot of those companies, whether it's through an M and A transaction, an IPO or so on. So to solve this, the government has made some new measures put in place around M and A activity, really trying to encourage in particular listed companies to acquire PE backed companies, trying to keep everything within the capital market system. But there's been a concerted effort from the government to enable some of these exits and for GPs and LPs to monetize their investments. I'll come back to this when we talk about some of the evolving views from the GPS and LPs. But again, quite an evolution in the private markets in just really the past 10 to 15 years. So again, you can see that there is a concerted effort to open capital markets to the world, but it's very careful, very controlled and it's slow. There's an evolution to a lot of this. I would say that today is probably the most open that we've seen in recent history. And the real reason for that is again trying to enable innovation to get more capital from investors to fund some of the initiatives that I'll talk about a little bit later. The real question of course is will it stay that way? And we'll also get to that later in some of the risks moving forward. So let's talk about some of the evolving views and participation from institutional investors in China. And I want to talk about this in two ways. First, let's talk about what they actually own and how that's changed over time. And then second, I want to cover some of the evolution of sentiment, the thesis behind China, and some of the rationales for why some of those changes might have occurred from a attitude or a thesis perspective. So in other words, I want to talk about dollars first and then we'll talk about feelings afterwards. So on the dollar side, just under 20% of the Chinese stock market is owned by institutional investors. So that number might be interesting to you, but it's useless without further context. When you look at other large economies like the US or other developed capital markets like Japan or the uk, that number is actually relatively small relative to what we see in other markets. So for example, institutional investors own about 41% of the US stock market, 31% of the Japanese stock market, and 26% of UK's stock market. So again, most of the Chinese market in the public markets, I should clarify, is owned by retail investors as opposed to institutional professional buyers. What I would describe a place like the US as increasingly institutionally owned. And this trend has happened over a long time. So 41% today was 20% maybe 20 or 30 years ago. And we've seen a more institutionalization of the market in the us. In China it's a little bit different, it's actually fluctuated over time. So just 10 years ago, institutional ownership of the Chinese stock market was just under 10%. So we've actually doubled in the course of 10 years. And some of that is due to some of the places and policies that were put in place over the evolution that I just walked through. But it has fluctuated. So just five years ago, so this was peak Covid time, that number was actually 25%. So we've seen a large fluctuation in terms of how much institutions own in China over time and hasn't been a linear line like it might have been in places like the us. So this tells me that we still have some dabblers. Obviously there's a bit of a sentiment shift that we've seen that I'll walk through. But this isn't all long term money in nature. Now in the private markets, China has roughly $3.5 trillion in AUM just in private capital. So we've talked a lot here on the podcast about the AUM of overall alternatives. So private markets plus hedge funds being at about 25 trillion. So China is a material portion of that overall allocation. However, most of that capital was raised in the mid 2000s. So to my earlier point, many of the GPs are currently looking for exits. But we don't have a very long track record of capital commitments, fundraising and exits over a long period of time. Remember that the private markets as we know them today only started in about 2010. And when you look at prequent data, a lot of those commitments really didn't pick up in earnest until the mid 2000s. So 2014 to 2016 to be exact. So we're seeing a lot of capital that's unrealized value waiting to be monetized in that aum. So we'll see how that AUM changes when you start to get exits and these funds begin to wind down. But right now about 3.5 trillion is in private markets. We've also seen some asset owners like cpp, gic, Temasek, invest aggressively in different parts of the Chinese economy. This is through private equity, venture capital, of course, but of also of interest is the real estate market, which we'll talk about in terms of some of the reset that we've seen in those valuations. But particularly in the mid-2000s to the early 2000s, real estate was a really attractive investment opportunity for a lot of these institutional asset owners. Now back to the AUM number, that 3.5 trillion. A lot of these asset owners might invest directly through funds which would be captured in that 3.5, but many of them do it through joint ventures or direct or co investments. So the private markets ecosystem may be larger than that 3.5 just due to the way that a lot of these asset owners are accessing the markets. Okay, let's talk about the feelings. So we talked about the money. Let's talk about sentiment and feelings. And what I mean by this is what US based investors are saying in their research reports. So I particularly focused on what US consultants, asset managers, GPs were saying over the course of really the past five to six years because there's been quite an evolution since that a share moment in the MSCI indices. And I would describe that evolution as going from one of pure optimism so late 2010s into 2020 to cautiously optimistic more recently with a bit of skepticism and potential bearishness here in the middle. So let me walk through that narrative shift now before I do I mentioned I looked at a lot of different reports and a lot of different sentiment indicators over the course of the past five to six years. But one thing that I wanted to find was is there a consultant or a asset manager that has consistently written about China? So I can compare that evolution from one particular type of investor and I found one. So Cambridge Associates, the large consultant OCIO organization, wrote a series of research notes on China over the course of this time period pre Covid to today. So I thought I'd walk through some of those narrative shifts. But I'm using Cambridge as my proxy just to show how same people were viewing the thesis behind investing in China over time. So let's walk through that evolution starting in 2019-2020. I would describe the mood sentiment as broadly optimistic and very much a beta play in China. So you had the A shares inclusion in the indices. You had a really compelling middle class rising story. You had a narrative on structural growth. There might have been some slowdown statistics in terms of gdp, but how they were going to get themselves to reverse that and how GDP was actually growing. When you looked at the underlying components components, a lot of compelling stories that were in place in 2019 to 2020 leading up to Covid. Now of course you get into Covid. So the 2020 to 2021 period things were a lot more mixed. You had some lockdowns that were taking place, zero Covid measures were put in place and the economy effectively shut down. Just as an anecdote, I remember being here at Kaya, we were on an all staff call in the middle of COVID and our CEO at the time pulled up Google Earth just to look at China and you could actually see China from the satellites. And this was just due to the lack of pollution that was taking place because of the lack of activity. So you had a country that entirely shut down during this period. So 2021 was also a period where the government made some very public crackdowns on places like technology, education and fintech, all of those sectors being areas of focus. It was also when the Ant group IPO was suspended. So John mentioned this later in his segment where the government came in, suspended the ipo. There was a lot of back channel conversations happening. Jack Ma eventually being somewhat ousted from his position. So that was taking place at this time. There were also threats of delisting and data restrictions that were taking place. And it was also the beginning of those tensions that we now have in full force between the US and the Chinese government now in 2022-2023. This is when things bottomed from a sentiment perspective. So you had the knock on effects of zero Covid Again, the economy shut down and so when that was in full force, you had a lot of other knock on effects. Exits dried up, the economy cratered in terms of growth and you had a lot of LPs that were in China that were either pausing their re ups or they were pulling back completely. Now in 2024 is when the narrative started to shift a little bit more positive. Still cautious, but there was a lot more to be excited about in terms of things like innovation, energy, transition themes and so on. And I'm going to talk a little bit more about that in the forward looking view. So let's talk about that forward looking view. So for this part I enlisted the help of William Ma, who is one of our board members based in China. John, by the way, William is a fan of the POD and is probably in the gym right now. So William, if you've made it this far, thank you for your help and good luck with your bodybuilding competition. William was incredibly helpful in helping me with some of the bullish points for China. It's really interesting to do research on this particular topic using US search engines and US media to try to build a bull case for China because quite frankly there's not much that's out there that's super positive. You get it from some anecdotes we'll talk about hopefully with Ed in the coming segment. Different asset owners and allocators that might be committing some GPS and managers like William to. But it's hard to put together a broad mosaic in terms of the bullish points for China. However, in talking with him, doing some research as well, there are some pros and I think some interesting long term trends that should be interesting to investors who are looking to invest across China. So on the pro side there are three themes that I want to talk about. First is innovation. Second is energy and third is trade. But of course there's risk. And risk is easier to find when I was doing this exercise and probably easier for many of you who are interested in the subject who are based outside of China, particularly here in the us. But on the concern side, that I want to talk about three things as well. So domestic policies being one, geopolitics being another, and then demographics. So let me talk about the pros and then we'll talk about some of the concerns. So on the pro side, innovation China is still the leading player in several innovative sectors and again this is the second largest, one of the largest economies across the globe, so it can't be ignored. But they have a lot of firepower Both through government policies, but also through their capital markets. So there's two that I'll talk about, electric vehicles and AI. So EVs are a huge opportunity here. More than half of new car sales across the country are EVs, plug in cars that are either fully or partially electric. So this is a huge opportunity for EV makers, battery technology, all the different parts of the supply chain. Across EV solutions, there's huge opportunity from that perspective. Byd, the Chinese EV automaker, has one third of the market share in China and the runner up is Tesla. So BYD is 1/3. Tesla only has 7%, so there's a huge head start locally.
- [68:51]
A
Aaron, have you ever ridden in a byd?
- [68:54]
B
I've not. Have you?
- [68:56]
A
So nice. So I've sat in one. I've not ridden in one, but last time in Singapore I was in one with a friend and then I saw a bunch in Mexico City a couple months ago. They are sweet cars. So much nicer, shall I say, than our EV fleet here in the States. It's a shame for maybe understandable reasons that we don't have access to them here because they are modern technological feats.
- [69:19]
B
What's so great about them?
- [69:21]
A
Well, I think just aesthetically they're much better looking than Teslas and I think the electronic digital capabilities inside are just much more advanced. So I just was really impressed. It's sleek, it's cool, it's trendy, and they look awfully good on the exterior too.
- [69:37]
B
Well, I have not seen one or ridden in one, but I think anything's better than the Roblox on wheels, that is the Tesla truck. So I'm looking forward to riding one someday. I think that speaks for itself, John. The market share number, I mean, it's staggering the difference. And Tesla, which is obviously a leader here in the US is far second place in China. So beyond EVs, I want to talk about AI. So on the AI front, obviously China had its Sputnik moment with Deepseek, but they're not stopping there. Huawei, the Chinese telecom company, recently announced their goal of building their own chips to compete with a lot of the US based AI chip manufacturers. So historically Nvidia was the market leader in this space. But with the Biden administration, now, the Trump administration, extending some of those restrictions and access to chips, the Chinese are saying we're going to go about this our own way. So the implications here are huge. On the innovation front, both on EVs, but particularly for AI, which has been the more recent story. If they're able to pull this off, they're no longer handicapped by the lack of access to US innovation. So that's innovation on the infrastructure side. The second theme that's interesting, John mentioned the new Silk Road initiative that was started in 2015 again through Huawei, through the China's state owned enterprise model. And the goal here was to be a global leader in digital infrastructure. And they've done a lot of work over the past 10 years to try to accomplish this, obviously with some controversy attached to it, but a lot of initiative and push from the government's perspective.
- [71:09]
A
Aaron, just before you go on from there, I heard an interview with Mark Andreessen on this subject and I thought this was really interesting because his observation was while logically I think we can all understand the Biden executive order that Trump seems to be continuing about embargoing high tech, most advanced chips, Nvidia in particular, to China, but that could have backfired. The unintended consequences of this are interesting. It could have hurt us in a couple ways. First is that just as what you said, China was incentivized to innovate with the lower cost, the lower performing, the slower chips and clearly Deep Seq, as you just noted, found a way, but perhaps even more dangerous long term. Again with China always thinking Several presidential terms, U.S. presidential terms longer than we are is that it developed an incentive to create an entire parallel semiconductor manufacturing industry and blocking US Capital from participating. So we lose in a bunch of ways. They do it more efficiently, more cheaply, they decouple and create an entirely new supply chain which by definition is going to split the baby. No matter who gets what market share, it's going to split the baby. And then thirdly is that we don't get to participate in any of that capital formation and capital growth. And I thought that was a really interesting observation is anytime you do these things as well intended and as logical as they are, there are always consequences you don't figure out till later.
- [72:31]
B
And I think that's a really good point from a US investor's perspective. But I recently did an interview with our good friend Marco Papich, who I know was on the podcast last season, but one of the things that he talked about was when you start to de globalize and there's this push from a fiscal policy perspective and we're seeing it here in the US China is certainly doing it as well. There's actually benefits in the aggregate in terms of innovation because now you're forced to compete R and D, which is clearly what China is doing. But to your point, if you're not speaking to each other and you have these capital controls, how do you access it in the first place? So maybe from a technology perspective, it's really good, but in terms of participation, much more challenging. Now, more recently, the Chinese government has expressed interest in becoming the global leader in nuclear power by 2030 and becoming carbon neutral by 2060. So this would effectively mean, if they're successful, leaving the era of oil completely behind. So going to high speed rail, again, EVs being part of this, but building an infrastructure that is sustainable and climate friendly in a very aggressive timeline. So again, nuclear power by 2030 and then carbon neutral by 2060. So lots of opportunity on the infrastructure side, which has historically been viewed as a boring asset class, but I think is really important in building the foundation for some of these different initiatives. Now, the third pro that I want to talk about is trade. Now, trade has been in the headlines more recently with some of the tariffs that have been put in place, some of the trade war rhetoric that's been in our media. But I want to impress upon listeners here that the Chinese economy is much less reliant on the US today in terms of trade. So outbound goods have fallen from roughly 6% of GDP in 2007 to less than 3% today. So a lot of this was accelerated by Trump 1.0, continued on by the Biden administration, and doesn't seem likely to reverse under Trump 2.0. Now, on the same token, US based revenues only represent about 5% of the market weight Chinese index. So for comparison, Taiwan, South Korea and Japan are all 45%, 28% and 24% respectively. So in terms of just exposure to US revenues, the US dollar and Chinese equities much, much smaller than what you see in other parts of Asia Pacific. So in some ways this is a risk management tool, perhaps a headline risk that's overblown. But I think more importantly, this is a pure place story on the Chinese consumer. A lot of what you access by going into China, particularly a shares, you're getting access to the true Chinese economy. Now let's talk about some of the concerns. So first I mentioned domestic policies. The CCP retains control over a lot of key economic sectors and there's a lot less confidence around how or when that could influence different levels of changes. So John mentioned that pragmatism, that's a huge question here and how much the government is willing to move towards more free market philosophy and policies versus more of that centralized planning and control. So there's recent examples of this. I already walked through the ANT IPO crackdown, some of the other regulatory crackdowns. So that's not far off history. That's recent history in terms of some of those changes. So the big question is, despite some of the swings back to more favorable private sector capitalist types of tendencies, the question is how stable that regime will actually be and how the balance between that free market philosophy and centralized planning will play out over the long term. Second is geopolitics. So this is an additional layer on top of domestic policies. This is a huge risk, especially more recently. Even if trade is less of concern, there's still a lot of wariness around investing in China as a foreign investor. So despite all of the groundwork that's been laid over the course of the 2010s by allowing access, we now have this additional layer of domestic policies. And by domestic policies, I mean here, locally, as a US investor to actually invest in China. So if you are an asset owner or an LP or even a GP who is trying to invest from the US into China, you're asking questions around is my investment going to be restricted? Do I have to divest? A lot of questions that are circulating around this. So for some that's just not worth the effort or worth the risk. Now of course there's also policies that have been put in place. The Biden administration on export controls on chips in 2022 was announced. I talked about that in terms of innovation, but this is also being Strengthened by Trump 2.0. So despite all the good things that are happening domestically in China, the real question is can you actually monetize and benefit from some of that innovation as a foreign investor? One other anecdote I'll put in here. There was an FT article that highlighted some of the shifts that were taking place just because of geopolitics. Some GPs have completely closed down shop in their Chinese subsidiaries, Sequoia being the big headline name. But a lot of LPs who have committed billions of dollars to Chinese markets are all starting to step back from those investments. So there was a stat over the course of the past couple of years. The largest public pensions in the US have committed around 70 billion in assets to the Chinese economy. And if you pull that away, that is quite a shift just due to geopolitics. And then third and finally are the demographics. So China is still digging out of zero Covid. We've seen some of the knock on effects of that by shutting the entire economy down. Crawling back out of that has been a Bit tough and it's been uneven for a lot of its citizens. So youth unemployment, for example, is still very high and there's a large demographic problem that preceded Covid, but it's certainly been exacerbated since then. You've seen real estate values being reset, drawdowns in real estate, which has had a negative impact on household wealth. And as a result you see things like saving rates, which are at all time highs. So in China, the savings rate for households is right around 40%. People just don't want to spend during uncertain times. And for comparison, saving rates are about 10% in the U.S. so there's a huge delta between what we see over there versus what we see here now. You could also view this as an opportunity. If this thing reverses, perhaps this is the worst that it could get. But there still needs to be a catalyst and the government is working on initiatives to try to spur that economic activity, to get the youth back into a healthy employment level. And then of course really divesting or diversifying their economy away from building real estate driven types of value as a contribution to GDP to much more of a consumer oriented story. So there's a lot of groundwork that's being laid here, but of course there's still a lot of struggles. And so the question is, when will some of these things reverse? So a few other things to sum things up from a portfolio perspective to close things off. When it comes to investing in China, there's a diversification story as well as an innovation story. So I talked a lot about the innovation and some of the exciting initiatives that you see in Chinese based companies. But the additional thing to consider here is that China has historically had a much lower correlation to other equity markets. So when you look at the us, the UK parts of the west, the correlations between those markets are relatively high, somewhere around 0.7 to 0.8 in that trading range. When it comes to China relative to those markets I just mentioned the US other parts of the west, it's much lower. It's in the.03 to 0.5% range. So in addition to some interesting innovation that you might be exposing yourself to, you're also getting diversification as a result, assuming the past looks somewhat similar to the future. The other thing to consider here is that if you're underweight China or you don't own China at all, you're implicitly shorting China, which is an active bet to make. Now that might look good here in the short term, but the question you need to ask yourself is, do you think that China will be around in five to ten years from now or will it not? Obviously they've got a much longer history than many other countries and economies and cultures. So if you're betting, I would say that it will be around in five to 10 years, which means that they're outlasting some of the more recent scuttles with the U.S. now, of course, there's a lot of career risk here, especially with headlines. And typically your investment committee or your board has a home country bias. So if you're in the US there's a lot of S&P 500 envy. And so questions around, why do we own this? Why won't we just own our domestic stock markets? That can be tough. But if you can build a compelling case, access and execute, that's very interesting and potentially could be very additive to your portfolio over the long term. So the question is, is China investable? I think it is if you can take a long term view and you can mitigate some of that career risk in the short term. But the main thing to watch for back to John's point early on in the segment is the durability of that pragmatism that is the key to all of this becoming a viable long term place to put capital.
- [81:35]
A
I think that's a great way to end. We have one more piece, listeners, to complete this study and that is the conversation with Ed Grefenstedt. We're gonna ask him a lot about what he's seen in his 50 trips and in his very early stage pursuit of China investment and how he's weathered career risk, as you mentioned, and a whole lot of volatility. You know, there's a couple quotes that we mentioned earlier, so I hope that gave you a significantly hefty foundation in thinking through both the political environment and the investment and economic environment. And I would urge you all to stay tuned for this halftime episode with our friends at Franklin Templeton. And then we'll be right back with Ed Grefenstedt.
- [82:18]
B
All right.
- [82:18]
A
Welcome back to Capital Decanted. As promised, we are now here with George Stephan, who is the newly named global coo, Wealth Management for Alternatives for Franklin Templeton. Welcome to Capital Decanted.
- [82:31]
C
George, John, thank you so much for having me.
- [82:33]
A
It's our pleasure. And we're extremely grateful for the partnership, of course, that we have with Franklin Templeton. I should welcome you to Franklin Templeton for that matter. You're only two short months in from KKR and I know they're excited to have you in this seat. And we're excited to exploit and take advantage of your wisdom both at KKR and now what you're attempting to build at ft. I thought as a result of that we could maybe very quickly survey the state of play in product development in wealth management. It's certainly a priority for you at Franklin Templeton and for many of your contemporaries across the industry. So maybe I'll start. George, both as a function of your experience in previous lives and now freshly into FT is that we've seen much of the product innovation to date to bring alts to wealth management has been variations of what I would call some form of a interval structure where you've got some level of limited liquidity at certain intervals, hence the name with periodic gates, meaning there's a maximum to it. What do you think we've learned as an industry generally about the advantages and disadvantages of that particular structure?
- [83:40]
C
Absolutely. Really? If you think about the structuring side, I think about five core structures or variations of the interval fund like you alluded to, all of which give individual investors the ability to access alternative investments in an investor friendly way. So you have the interval fund tender offer, non traded reit, BDC and operating company, all of which have similar attributes with slight deviations. But before I get into the advantages, I think you need to take a step back and think about the history of these products. So if you take a step back and think 10 to 15 years ago, there's obviously been this massive evolution in the semi liquid products. The prior vintages or the 1.0 versions of these products were built by less experienced managers. They had high upfront fees, multiple layers of management fees, they didn't value portfolios frequently and they didn't utilize leverage appropriately. But what you've seen over the last several years is large gps have come in and redefined how these products look and feel. So they've essentially learned from a lot of the various mistakes that previous managers have made, which I think has really tightened up the investment access and the client experience. So if you think about today how managers view these products, there's really a couple of core guiding principles. Institutional style pricing, institutional investment access, more transparency and a lot of education. These structures make it easy for individual investors to purchase these products which has been critical for adoption. There's no capital calls. These structures deliver instant exposure to seasoned portfolios. 1 Eligibility 2 Typically they're offered to accredited investors, in some instances the mass affluent. These products are continuously offered on either a daily or monthly basis. They have low minimums to invest. From a liquidity perspective, they're probably providing liquidity in quarterly intervals, roughly 5%, simplified tax reporting, and a more frequent and robust valuation process.
- [85:28]
A
Really helpful and I think listeners will know that Episode two of last year we outlined much of what George is saying as far as the pitfalls and some of the challenges that liquid alts 1.0 faced. And it's so great to hear that what you've just articulated validates our experience that some of those lessons are being applied. So I appreciate that overview, George. And so maybe part of this is addressed in some of the solutions that have been based upon what we learned and where we made mistakes the first time round. But as you look out so that's a bit of a retrospective, George. If you look out a few years and you think about whether it's Franklin Templeton's own product ambitions or other activity and velocity you see across the industry, where do you expect to see the most innovation? Either in product spec for the current interval variations or in asset classes or some combination of both.
- [86:21]
C
So maybe we start with the structuring question. Then we could go into where the puck is going from an asset class perspective and where the puck's going from more dynamic portfolio solutions. I mentioned the five structures before. I think what you're going to see in the future here is a lot more focus on the pure play, interval fund and tender offer. You're going to see them predominantly pop up. The reason being is they trade very similarly to the mutual funds, so it makes it easier for advisors and clients to do the business. That is no subdoc. It's click and purchase. They sit on the mutual fund chassis. More gps are going to try to offer solutions to the massive fluid audience and it's probably the ideal and best way to do that today. I think you will also see fintech companies continue to make it easier for investors and advisors to utilize the other core interval fund structures. But I think from a pure play structure and perspective, you're going to see more interval funds and tender offers pop up. On the asset class side, what I would say is real estate, equity and direct lending are the most established asset classes and investors are going to continue to allocate to them. Real estate has had a slowdown over the last few years given all the obvious fundamental reasons, but you will probably see an uptick in demand over, call it the next one to two years as fundamentals get stronger. Direct lending and private credit more broadly will continue to be high in demand and grow at a fast pace what you are going to see in private credit, a lot of managers are going to start to add additional standalone flavors such as asset based lending and real estate credit which are a nice complement diversifier to direct lending and another way to essentially get 9 to 11% yield on the PE and infrastructure and PE secondary side. What I would say is you're still seeing a lot of entrants come into the market and those are probably three of the fastest areas of growth over the next few years. At Franklin we are extremely excited about the opportunity in PE secondaries institutional investors need for liquidity given the slowdown in broader exits is a very real theme and I don't think there's been a more exciting time to be an investor in PE secondaries. In infrastructure it's such a unique asset class and one that's been under penetrated by individual investors. The way I think about true private infrastructure, it's resilient to economic shocks and it has low correlation to other asset classes. So it has a real need within a portfolio. As I mentioned, it's not an asset class that historically individual investors had access to. So I do see a lot of demand coming there the next. And this is going to be a common theme for years to come. It's this notion of public private accommodation fund. You've seen a couple of things in the news as of late, but essentially a combination of public and private securities, predominantly credit driven for now, wrapped into one portfolio. It feels like a trend we're going to see over the next couple of years. And going back to the structuring point, I think the interval fund structure is probably the most appropriate structure for this today because it allows you to have a higher allocation to privates but still go down to the mass affluent. I think we're a few years away and regulatory easing and relief from being able to facilitate privates and ETFs more than what we've seen. What I would say is there's still a large cohort of advisors who have not yet adopted alternatives. Think about a multi alternative solution where either through a managed solutions or through one offering you can provide that cohort of advisors the ability to invest across a broad pool of alternatives across every single one of the asset classes we've talked about. I think there are going to be managers that figure out how to create these model portfolios or how to create a product that delivers one holistic solution across all asset classes in a simplistic way.
- [89:48]
A
George, I couldn't agree with you more on that last point. The multi manager solution. I think is the holy grail. Of course, that's a whole lot easier said than done with all the mismatches and toggling between underlying asset liquidity and, of course, the liquidity gates that are on the overall wrapper. But we'll leave that to the product experts. But that's been a fascinating tour of where we're going. I think, if nothing else, as we've seen from the tsunami of news flow that you alluded to, we're in for a lot of change and a lot of new opportunity and innovation. So, George, thanks for helping us think through this. And listeners will be back with our guest segment.
- [90:23]
C
John, thank you so much for having me.
- [90:27]
A
Well, welcome back to Capital Decanted, and I am delighted, as promised now to be joined in studio by Ed Greffenstedt, CEO and cio of the $1.5 billion Dietrich Foundation. Ed, thanks so much for joining us on Capital Decanted.
- [90:43]
D
Delighted to be here. Thanks for having me.
- [90:45]
A
Well, Ed, we have spent a lot of time these poor listeners have beared with us in a short history because obviously China has a very long history, but a particularly relevant short history that I think really sets the context and the apparatus for answering the question du jour, which is whether modern China is still an opportunity to invest for the intrepid or perhaps the naive. Have things changed? And so that is really our task today, that I know your long experience, almost 50 visits to China, as we talked about in the green room, that you are uniquely qualified to help us with. But before we jump in quickly, Ed, why don't you just give us a brief thumbnail of what the Dietrich foundation is and your role there.
- [91:29]
D
Dietrich foundation is a charitable nonprofit organization based in Pittsburgh, started by Bill Dietrich. Bill was an industrialist, had a steel products company he sold in 1996 and decided in the history and tradition of Andrew Carnegie to give it all away. So he put it into a trust, grew those assets nicely to 500 million. When he hired me in 2010, I'd been CIO at Carnegie Mellon University and joined him promptly, told me he had cancer, passed away the following year, and that triggered the creation of the foundation with the assets that had grown to 500 million by then. Since then, we've given away about $350 million and we've grown the balance to $1.5 billion. We support 15 nonprofits that we list on our website. Carnegie Mellon University and the University of Pittsburgh are the two largest beneficiaries from the foundation.
- [92:20]
A
Well, it's a wonderful story. And Bill's legacy. You have carried on with great class and integrity. I'm sure he'd be proud. So, again, thanks for spending some time with us, listeners. We are going to do our best here, and this is going to take some discipline and some self control and perhaps even some supernatural gymnastics here to stay focused on a progression that Ed, Aaron and I agreed to, which is first, I want to unpack, let Ed really unpack the reasons that they have felt so bullish on China for so long and why that's been a very critical piece to, to their investment thesis as a result, to their investment allocation for many, many years, as you'll hear. Then I want to jump into tackling the question of the day, as I've already alluded to, which is, have things changed economically, leadership wise, environment wise, particularly as a Western investor. And so we're going to try to build from there. There will inevitably be some times where we cross in between those borderlines, but that is the hope as we begin this dialogue. So, Ed, I want to start, as I've just promised back at the beginning that you just quickly alluded to, which is even five years before you took the job formally at the Dietrich foundation, you had gotten to know Bill a little bit, and you describe, as I've heard you a couple times, him returning from China almost giddy with excitement, telling you in this whispered, excited state about how pumped he was for the opportunities in the People's Republic of China. And you said something to the effect of Bill, the only way to make good money in Chinese VC is to invest it, lose it all, and then write a book about it. So as you look back, obviously with a lot of much more experience now in assessing your initial visceral response, why was Bill right at the time and what had shaped maybe your initial reaction back then?
- [94:04]
D
Well, that's an accurate characterization of that lunch meeting. It was in 2005, and you described it well. Bill had returned after having visited China several times in the 1990s and having formed an opinion and view of China at that time, which really bore no resemblance to what he saw in 2005. So when he returned, he was quite excited indeed. And I know he started the conversation by looking at me and saying, ed, do you know who Henry Luce is? And I said, I think, I think Henry Luce was founder of Time magazine. He said, correct. But he also said something in 1941, he famously declared the 20th century was the American century. And by God, he was right. And I said, okay. And then Bill leaned in and said, now, Bill Dietrich's telling you in 2005, the 21st century is the China century. And I shook my head, as you are doing right now, Aaron, and I said, wow, Bill, it's your blankety blank money. You can do whatever you want with it, but I think you're crazy. But he was not crazy, and he had a perspective on it that I thought was, in retrospect, quite prescient. But my visceral reaction was really based on having never traveled at that point to China, was based almost entirely on having read a book called Mr. China, which was published only a year prior. And it covered in painfully funny way, the investments that were made by a couple of fellows in China in the 1990s ended up losing $400 million or so. But the book really characterized the investment opportunity in China as a complete free for all. And that was my only real experience and perspective on it. Of course, American vc, United States had demonstrated for decades the power of vc, but in my mind at that moment, it was purely an American phenomenon. I didn't see how venture could really be profitable in a country like that. But Bill's instincts were spot on. And he had a perspective that really started with the fact that he was a historian as well as an industrialist. He got his master's and PhD in political science from the University of Pittsburgh in the 1980s and in fact wrote a book about Japan in 1991 called in the Shadow of the Rising sun, the Political Roots of American Economic Decline. So he was talking then about Japan's ascendance, and he was actually in the process of writing or thinking about writing his next book on China. So When Bill in 2005 said to me, listen, you don't quite have the perspective as to why this is an exciting moment, I leaned in and I listened and he talked a lot about what he was seeing.
- [96:47]
A
So, Ed, can you expand on that a little bit? What was Bill particularly excited about that he had observed in his. You said about 10 years he had been visiting, and there seemed to have been this structural shift that he was particularly optimistic about.
- [97:03]
D
Yes. And again, we're talking 2005. And you have to remember that CENA had just listed a few years prior, maybe it was five years prior on nasdaq. That was a micro blog social network company in China. So they had already broken the barrier to list in the US in 2004. Tencent listed in Hong Kong, which was also notable. Baidu also had an IPO in 2005, and NASDAQ Alibaba had received a $1 billion investment from Yahoo in 2005. So these were things all on the heels of Bill's visit. But there was also one other thing that happened that he shared with me, and that was in 2004, I believe, Silicon Valley bank hosted a delegation to go to Beijing, and they brought 20 or 25 leading US GPs to meet with the early investors in the Chinese VC ecosystem. And that was a really seminal moment in the maturation of the Chinese VC market. And the folks that came, I'm told I was certainly not on that trip, was Don Valentine from Sequoia, Don Dixon from dcm, Jim Breyer, Maxcel, nea, ggv, Lightspeed, Bessemer. It was a who's who making that journey. So here's Bill sitting back and observing all of this and saying, listen, the markets are starting to demonstrate these are real exciting assets listing. These are very smart people on the west coast of the US who now see that perhaps the ingredients are coming together for an ecosystem. I should be paying attention. And that's counter perhaps to the conventional view of people walking around the U.S. at that point, that the Chinese ecosystem was not mature enough for dollars to be deployed. But Bill didn't feel that way. He felt that China was a special place with a spirit of entrepreneurialism. They had enormous engineering horsepower. They clearly had the scale opportunity with a singular population, 80, 95% Han, singular language, Pudong wa. So you had the common Mandarin spoken by almost all the population. These were all things that Bill saw from a historical perspective that to him said, hey, this is an exciting moment. And perhaps this can scale even to the point of being as attractive as the US VC marketplace.
- [99:24]
A
Hey, Ed, just real quickly, I can't help but your point on having just read one book and maybe some naivety as perhaps a lesson for us Westerners sometimes to draw conclusions based on our own experience. I think it was Margaret Thatcher. I recently read that when she went to visit Deng, she was channeling an old Chinese maxim that basically said, I was wrong. You have to see this for yourself. There's nothing like expression experiencing this for yourself. You cannot read about it, you cannot hear about it thirdhand. You cannot draw assumptions and conclusions. And I think that if there's anything you hear, experiencing what China has done has to be firsthand. And obviously you've got the benefit of that now, 30 years later.
- [100:06]
D
I agree totally. In fact, I recall I made my first trip in 2007 and I came back and this is classic human behavior. You get a little bit of information about something and suddenly you have enormous confidence that you're expert in the topic. I think it's the Dunning Kruger effect. A little bit of information can be a dangerous thing. I remember coming back and telling my wife, I'm an expert on China. Ask me anything. And then after my 10th trip, I came back and said, this is a really complex mosaic. Maybe I can maybe have some intelligent comments to make. And then after your 20th, 30th trip, you realize it is truly an other experience. And Westerners, you're spot on. Have a tendency to look, I think, at China through a lens that is Western. And you have to recognize this is a very different culture with a different history and a different sense of purpose and destiny. China doesn't want to be the U.S. china wants to be China. And until you grasp that, it is a confusing experience a little bit. So it's a good point set on the topic.
- [101:08]
B
Maybe more of a contrarian view that Bill had. So China was obviously one of those views relative to your view coming in, but also the belief system early on that private capital, private markets was an important piece of the portfolio. And as you've allocated capital within the foundation, it's been much more towards the private markets. Somewhere up to 90% of that allocation across buyout, growth, equity, venture. And China has played a large portion of that allocation as well. So I would love for you to maybe talk about China's role in the portfolio and how that's evolved over time and maybe going back a couple of years ago to when I believe China was a pretty large portion, maybe a third of that allocation and has since come down. But how do you think about that in terms of risk, reward uncertainty and potential career risk looking different from your counterparts?
- [101:58]
D
I'll elaborate a little bit on the asset allocation piece because I'm sure most of your listeners are thinking that was a verbal typo, that 90% couldn't possibly be 90% private. But no, it is spot on. We are about 90% private strategy right now. So 90% of our NAVs in venture, growth, equity and buyout funds around the world. And first, why we do that, and then I'll address China generally. Bill and I shared a strong view that there's an opportunity with an imperpetuity pool of capital. And that opportunity is to be as illiquid as possible because we felt that over time illiquid strategies would reward the patient investor. And that, of course, comes from a lot of experience, but also comes from a conceptual view we had, namely that public equities provide you with this Extraordinary luxury. Public equities provide you with the opportunity for a fractional share ownership of a listed company that you can turn to cash with a snap of a finger. And there's no free lunch in this world. So what do you pay in exchange for that luxury of turning a fractional ownership into cash in T plus what, 1, 2. What you pay is lower expected returns. You have to pay something. So Bill and I had this conceptual agreement that private equity was actually true equity returns. And on the public side, this is flipping on its head, this whole concept of a illiquidity premium. We always actually, the illiquidity is the actual true equity return and everything else, you accept a discounted return for this liquidity luxury. So we'd always say the same thing. Liquidity is not free. Liquidity is not free. So we agreed that we would pursue this experiment, if you will, of pushing the envelope and being as illiquid as we could possibly be. And that was a first principle for us. In terms of the support for that, I think your listeners are probably familiar with the fact that I think in 1996, or 8,000 or so US publicly traded securities, there's half of those today. And yet the number of private companies continues to grow. In the US I think there's 350,000 companies with over 50 employees. So you have a larger opportunity set and then the private equity end of the market, I'll start there first. You have a high level of inefficiency. You have opportunity for operating improvement. All the things that your listeners are very familiar with, which drive the thesis that private return should be higher than public. On the venture side of things, we also shared the view, Bill and I, that venture was the longest dated, furthest out of the money option you could buy. And if you're in an imperpetivity pool of capital, yeah, you should be pretty heavy on that layer. On top of that, we felt we were, and I think most would agree, humanity's in an innovation wave, and we wanted to participate in that to the greatest extent possible. And we felt venture was the place to do that layer. Yet more on top of that, on the venture piece, we felt like capital efficiency was just getting stronger and stronger, which made very, in our opinion, much more attractive to go into early end of the market and venture. So all those things conspired for our unconventional philosophy of being as illiquid as possible. So that answers what we're doing out here on this island, unlike most others with such an allocation. But then China, your question was, how do you get to a third of the portfolio. And to be precise, actually our high water mark was the end of 2020. I remembered vividly where 37% of our portfolio was in China. And we certainly didn't plan on that. It just so happened it was a first class problem. We had achieved a lot of gains unrealized in China from our early venture investing. It started in 2006 and it just blossomed into a portfolio exposure that put us there. I'll jump later on in this conversation probably to how we're managing today, but Today it's about 18 or 19% of the portfolio. So it's come down quite a bit from actually surprisingly to many, a lot of distributions came out so we could turn that into cash. We've been more slow and deliberate in future commitments and we've had some markdown in the last two or three years. So all those things have pulled that allocation exposure rather down to about 19% in China.
- [106:17]
A
Well, the D word distributions, Ed, I haven't heard very much lately on this show or anywhere, so well done on receiving some cash back. Always a good sign.
- [106:28]
D
2024. I was telling someone the other day about this. We had a surprising year. We're trying to figure out if we were just lucky or good or maybe a little bit of both. But we had our second highest year in distributions ever in 24, and the second highest net cash distributions over capital calls. So we were very fortunate and it was pretty broad based. So I think the distribution concerns that most are wringing their hands about today is real. But for those who leaned in and deployed a lot during the frothiness of 19, 20 and 21, they're probably the ones who were feeling the most pressure today. We were a little, I'm glad to say, careful during those periods. So we didn't push the deployment pace like the fundraising was being elevated. So we didn't get out over the tips of our skis during that froth. But I think we're touching wood and we're very grateful that we are where we are right now.
- [107:24]
A
I want to press you a bit more on this thesis over the last 20, 30 years even, because even if it was a first class problem, clearly you had strong conviction to even get close to 37%. So I think maybe one of the most important lines of discussion here that we talked a bit about in the intro and that I'd love your much more expert opinion on is this idea of pragmatism. Because I think one of the major misunderstandings of the PRC in the west, particularly in modern China, let's call that post Mao, when Deng took over, is this peaceful coexistence, you might even call it tension at times between centralized planning, what the west calls socialism or even communism, and this increasing experimentation with market driven policies. And Deng had a phrase called socialism with Chinese characteristics, and Zhang developed that further and called it socialist market economy. And so you always had, through the ups and downs of cycles and political transitions and geopolitical challenges, this ballast of pragmatism that I think the bulls which I'd put yourself in over the years would rely on in times of unsettling news when everyone else was running. So can you talk a little bit about the role of pragmatism in your long term thesis for China?
- [108:40]
D
Happy to. But I also want to preface my remarks by saying I'm sure there are many, many listeners out there who are studied in the history of China far, far better than I. But I'll just share with you what I've learned because Bill was a very strong advocate for reading. He himself, I should add, in addition to being an academic of sorts, he just had a lifelong passion for history. And when he passed away, I was executor of his estate and had to go through his library, discovered he'd read 4,000 books in his life, which is a staggering number. And no fiction there, though. Histories, biographies of great men and women, political science, economic policy. So Bill always had a book in his hand. Of course, he's always shoving me a book saying, read this. So I'll give you my perspective on this very important question. But I'm sure there are listeners who would edit it significantly. So when I think about this, what led to Bill's excitement in 2005 to start leaning in, I think it was his appreciation for what had transpired in the 70s, and really from 72, which is when Nixon visited China, through 79, when Deng Xiaoping visited Jimmy Carter in the US and toured the US and the famous picture of him wearing a cowboy hat, that was a really important period in building Deng's vision, I think, for what would come in China. I remember reading that Deng, after finishing his visit in 79, to one of his aides, he reportedly said, look back over the last several decades, all the countries that foster good relations with the US become rich. So he said we should do the same. So in 78, I think relations normalized. But it was really when Deng Xiaoping went back and thought about what really reform and opening up could mean and how he would engage not just with the US but with the broader economic community internationally, there's no doubt that was foundational to the opportunity set that would materialize in the 2000s. So that strategy that Deng Xiaoping talked about, reform and opening up, required foreign investment, required foreign trade and knowledge and technology and cooperation. But those reforms created space for private enterprise to support this government led priority for modernization and growth. So I think the pragmatism that you reference was core of that. Deng Xiaoping said many things that have been quoted, some actually, I guess there's debate about attribution. But he did say, it doesn't matter whether the cat is black or white, so long as it catches mice. And of course he was referring to the economic liberalization policies that he was employing. I think he got some challenge. And he said to some of his leadership colleagues, socialism with Chinese characteristics means essentially, if it works, we'll call it socialism. So these economic enterprise zones that we're experimenting with, it really is socialism with Chinese characteristics. But as long as it's working as socialism. And in fact, these were core market based principles. Another quote, he's given some attribution. Again, this is one's debatable, let a part of the population get rich first. But I think conceptually that was a fair thing to have attributed to him because I think he recognized, hey, this is going to be lumpy in the beginning, but we got to do it. And if you look back, what happened after 1979, the prosperity that was unleashed was undeniable. It was incredible. 800 million people pulled out of extreme poverty. The boom that really happened in China over the following decades is unprecedented in history. So I think that the pragmatism that he displayed was critical to that. And you're right, Jiang Zemeng and Hu Jintao in their presidencies from 92 to 2012 really didn't articulate anything fundamentally different from that opening up philosophy that Deng Xiaoping put into place. In fact, I think they just added to some of the stability that Bill and I thought was worthy of us continuing to invest. They talked a lot about and quoted Deng Xiaoping and saying, well, listen, we have to develop our capabilities while keeping a low profile. There was also this acknowledgment on international affairs that we can't arouse unease with our neighbors as we ascend in the economic clout. So they saw neighbors as sources of investment and expertise, but didn't want the hostility that might come from appearing to be a threat. So that was another feature of the Chinese development from 92 to 2012. Which gave us more confidence to continue to invest. So that was part of it. Now, when Xi showed up in 2012, he inherited a China that was vastly different from the China of his predecessors. China at that point had grown to be the second largest economy in the world, having gone through these two decades of double digit growth. And it was the world's largest trading country. So it was an export powerhouse that accumulated $4 trillion in U.S. reserves by 2015 or so. So it was a very, very different China. And with that came challenges. And part of the challenge was you couldn't keep a low profile anymore. You're now out there in the middle of the stage. And for Xi Jinping, I think we have to be somewhat sympathetic, or maybe there's a better word for it. We have to acknowledge that this was no longer, as the saying goes, crossing the river by feeling stones underfoot on the riverbed. They were now out in the ocean. There was now no feeling under your feet. So it really is unchartered waters for Xi Jinping to take over. And now China has a very, very different role and it must step up and acknowledge that there's no low profile anymore. But the pragmatism under Xi, though, was also present. I think for the first term or two, we saw opportunities where they could have recoiled from market based principles. But really, until I'll call it 2021, it seemed as though China was continuing to be committed to the opening up reform, the Dengism that we talked about. But then in 21, the common prosperity objectives began to surface as she introduced this concept of, hey, we've succeeded in essentially eliminating severe poverty in our society and now the focus has to be on income inequality and to ensure a harmonious society. Now common prosperity has to be the.
- [115:40]
C
Name of the game.
- [115:40]
D
And that was a big and new priority established in 21. Unfortunately, I think most, even those who are charitable, would describe the execution of this concept in terms of policies and regulations from 21 to 24 as having a fair number of missteps. And a lot of those created the both domestic and international loss of confidence in the policy directions and the predictability of the policies that I think has undermined to some degree the interest in risk capital like ours going into that market, at least for the time being. So the common prosperity concept, the common prosperity objective that really surfaced in 21 began to go back on the back burner. In fact, you haven't seen a lot of use of that term since late 22. I've often said that you can't have common prosperity without prosperity. So maybe that's really what's going on. But I think that in this moment in time, we're talking here In April of 25, the first three or four months of this year, you've seen evidence of moving back to pragmatism. You've seen the evidence of pulling all the tech executives to Beijing for an important conversation where Xi himself articulated the importance of market based principles, the importance of, of technology leadership, the importance of these companies in succeeding and growing. So in my mind that is a positive, very, very positive sign and maybe evidence that we are now pivoting once again back to pragmatism because it's really necessary for China to get across the river.
- [117:26]
B
I want to drill in a little bit on the implementation of the thesis. So you talked a lot about the backdrop which I think is important in terms of why going in to China and the things to think through from that perspective. But how you do it is also another piece of the puzzle, if you will. And I'd love for you to talk a little bit about the evolution of how you've invested in China, particularly since Bill first made this move in versus your evolution over time. And maybe two lenses to think through. One is the initial entry point into China was this broad base spread across a lot of different GPs, a lot of different strategies, mix of local foreign investors. But since you've taken over the CIO seat, you've concentrated that effort a little bit further, but still had that focus on the local investor as well. So could you talk through both of those thought processes and decisions to concentrate, but also maintain that local GP exposure?
- [118:21]
D
Yes. In 2005, when Bill was describing for me his strategy for executing on this vision, he said to me, Ed, listen, there are too many unknowns right now. There are too many unknowns for us to make one or two bets in China. And I said, well, explain this to me because he was expert at that point, I was not. And he said, we don't know what the exit markets are going to look like for these investments that are being made. We don't even know who the regulatory agencies are they're going to regulate in China whether it's going to be the csrc, the ndrc, the Ministry of Finance. There's a lot we don't. We don't know whether this vie structure which is necessary for private companies to get around or circumvent the prohibition on equity ownership by foreign investors in certain sectors. Let's take this thoughtfully and slowly and his decision which was a sound one, was place small bets across a number of gps. In the beginning they don't have a long track record. So let's get to know these GPS and then over time use that sub portfolio, treat it as a set of options and then as we get to know these gps, we can go deeper with a high conviction subset, which made total sense. So Bill began that process in 2006 and 7. I mentioned earlier that SVB trip that was sponsored in 2004, 2005, that led to a couple of US firms joining forces with GPS on the ground. IDG Excel was an example of that. IDG was already in China. Accel Ventures teamed up with them. Of course Sequoia ultimately got Neil Shen. So there were examples of US firms that were setting up, putting a flag on the ground in China, but there were also China homegrown teams. And Bill had a choice to make. And he said, who would I rather bet on? The people who were flying in to perform diligence on these Chinese founders and Chinese companies? Or do I want someone on the ground? Do I want someone who is local, who understand the nuances, can understand the right people to contact, do proper diligence, have the Guangxi, have the relationships necessary to source and vet these opportunities? And Bill made the decision, again, wise, I think that he would rather have local teams. He thought the transoceanic teams were going to be ineffective. He thought it was foolish that some IC sitting in the Bay Area in the US was going to be able to operate as effectively and as quickly as may be needed to capture some of these fast moving opportunities. So his bottom line was the companies are local, the investors should be local. So we really focused on Chinese teams that had the autonomy to deploy, the autonomy to move quickly and do it in a thoughtful fashion. So he started this process with really local teams and that continued over time. You're right, Aaron, we did end up leaning in. And right now I'd say our core relationships are down to about four and we're quite comfortable with that.
- [121:36]
A
So, Ed and listeners, as I promised, I want to start transitioning and you gave us a bit of an amuse bouche a few moments ago with your current assessment of xi, which I want to push on a little bit more. But there's a tension going on currently as we shift to current state and whether things on this investment thesis you've articulated really well are changing, are being undermined, are simply continuing on that same path of pragmatism versus reality. And that is on the one hand, especially In VC Ed, which is an area you look at, as we've talked about with some excitement in history, is that it's diversifying significantly the Chinese economy, particularly the new economy from Internet and E commerce. You mentioned Baidu, you mentioned Tencent, the national champions, the darlings of the first couple decades of this reform. And now there's a lot of, with a lot of government fiscal stimulus, enterprise SaaS, green clean energy, semiconductors, life sciences. So on the one hand you've got this breakthrough and diversification of technological opportunity at the early stage. On the other hand, you could look at the fundamentals right now, the cyclical economy and this decoupling, this trade war, the real estate collapse, demographics, deflationary fears. You could go on and on and say how do you weigh the current cyclical state of the economy and this long term movement towards what appears to be an even broader buffet of VC early stage private enterprise opportunity? How are you balancing those two forces right now?
- [123:08]
D
Well, that's a good question. It's a hard one. We're trying our best. But before I talk about what we're still excited about in terms of sectors and specific investable opportunities in China, let me make a broader comment about this moment. Henry McCann is one of the Greylock founders, once said, and I've always remembered this venture works best when money's expensive and time is cheap. And when the reverse is true, be careful. And we're at a moment now where in China money is expensive and time is cheap, which means you have time to conduct diligence, you have time to meet with founders, you have time to structure an investment just the right way. And the doo dah days of 19 and 21 in the US money was cheap, time was expensive, you had 48 hours to review a term sheet and deploy. This is quite the opposite right now in China. So from a lens of the supply and demand of capital, whether it's appealing or not is very appealing right now. People have the time to do their work. So that's a very positive moment, positive piece of this current environment. But specific to the question of what sectors stand out as looking attractive right now, there are several. And let's remind ourselves that China invests 500 to 600 billion a year in R and D. It's only second to the us it's more than Japan, more than Germany. So there's a constant flow of research dollars going into R and D, into the technical fields and the areas that we think have a lot of appeal right now. And these are all subject to the challenges of navigating the US restrictions now, which is a non trivial step in the process. But deep tech and AI and EV and I'm also talking about electric vertical takeoff and landing equipment. There's really exciting stuff happening. The humanoid robotics field. Obviously semis are untouchable right now for US investors, but there's a lot happening there. They're going to have spillover effects and then just innovative tech enabled B2B and enterprise software opportunities. I'll pause on that for a moment because here to date China has not really shown there was great promise around SaaS three or four years ago. But it really hasn't proven to be an exciting market because enterprise customers are very slow to spend the money necessary. By all the metrics, the cloud based tools being utilized in China are a fraction of Europe and US and yet the companies just haven't been willing to spend. Exciting moment happened with deep SEQ and the response and the enthusiasm that flowed from that by the government. The government actually recently gave a directive to all the SOEs out there saying listen, you must move as quickly as possible to embrace AI tools and improving the operations and efficiencies of your businesses. This could actually be therefore an exciting moment to see if finally AI driven software tools begin to get embraced by both the SOEs and the private businesses. So I just wanted to double click on that. But healthcare is another area where we think there's emerging innovation in China. The biotech and drug development out licensing for the global markets is a very strong tailwind right now. I think China's homegrown biotech innovation is really only second to the US right now. So there's a lot of reason for enthusiasm around that. Domestically, China's healthcare spending is going to double in the next decade. That's guaranteed. But in terms of outsourcing or out licensing, that's a really exciting tailwind. And then in the consumer space, you're right, the E consumer play, it's in late innings there. We've had the dominant players emerge, but there's now this movement, I think toward homegrown brands. So that piece of consumerism is still attractive. China has been very conservative. Consumers have been very conservative in spending over the last several years. I think they're spring loaded. The household cash balances have grown dramatically and I think it's just a question of will they get the confidence to start spending and when they do, I think it's going to be an exciting time for a lot of homegrown brands. So there's a lot of areas that we're excited about. Of course, all these are subject to what the latest and greatest is going to come out of Washington D.C. and what we can and cannot invest in, which I didn't think was ever going to be a major hurdle for my decision making process, but it is now. So we have to do everything around that. But I think the Deep Seq in particular is an area that has generated a lot of enthusiasm and excitement both among the leadership in Beijing and in the commercial community. And I'm sure your listeners are all familiar with what Deep SEQ is, but it was founded in 2023 as a next gen AI company specializing in open source LLMs and it got a lot of this global attention in January. It was December of 24, January of 25 when they announced this advanced capacity that effectively matched ChatGPT four level performance at a fraction, reportedly at a fraction of the cost. And it really has accelerated from our perspective, the thesis that hey, this infra layer is going to be commoditized pretty quickly and now it's going to be what sits atop this layer and the opportunity for exciting apps both in the US and China is substantial, of course, but specifically to China, the Deep Seq had another layer to it that in significance that I wanted to highlight and that is that perhaps it showed more than anything that generative AI is more about engineering than brute force compute. And what do I mean by that? Perhaps this now shows how darn good some of the Chinese researchers are and development people are because they can replicate frontier level capabilities with a fraction of the compute thought that we all thought was necessary. So I think everyone's stepping back for a moment and saying, hey, this is an eye opening moment if all the reported information is correct, which is always a big assumption, but if it's true, then maybe the gap is not quite significant as people thought. Maybe this idea of hey, we can contain China by limiting them on the chips they have access to, maybe that's not as successful a strategy for the US government as they thought. There are a lot of questions that come out of this, but Deep Seq is an exciting and big open question right now.
- [129:55]
A
So many have called the Deep Seq release a Sputnik moment. And I actually think by the way, BYD on the EV side is just as much of a Sputnik moment. I spent some time, I got my first BYD in Singapore a few months.
- [130:08]
D
Ago and what do you think about that?
- [130:11]
A
Unbelievable. I think it's the best car, certainly the best EV in the world. And it reminds me of a recent quote, we had this closed door meeting with a bunch of CEOs in LA about a month ago, Aaron will remember. And this chairman of a large private gp, private equity GP said the Chinese are doing everything better than us in the new economy. Now even if you scrub away some hyperbole in that, the point is, as you've just described, there are a lot of opportunities right now from a VC and early stage perspective that the Chinese are surpassing, leapfrogging, leading at least competing with anybody in the West. But I want to play devil's advocate again and press back a little bit Ed, which is that arguably China is also facing a fiscal challenge that they haven't had in a very long time. And this property collapse and the debt that is on both the state's property books and then the local level officials who usually are the ones stimulating all this local growth are a bit cash strapped and the households are cash strapped. Hence this prosperity move by Xi. So despite the innovation, can these organizations rise in an environment where there is a focus on improving the balance sheet versus growth right now in China?
- [131:26]
D
Fair question. And we have to look at both sides of the ledger when we talk about China and there are serious headwinds, some which you've put your finger on. Yeah. Bill said to me often, by the way, this is early in our time working together. He said always remember that when you invest in China you have to tolerate really sharp ups and downs in sentiment. He said it's like the cutting edge of a saw, it's that sharp. And just remember when things are sharply up and everyone thinks there is no worry in the world, things are never as good as they appear. And when sentiment on China is sharply down, rest assured things aren't as bad as they appear. And I always kept that buried in my mind. But this moment might be a little different because I think this isn't just about sentiment. This is about fundamental challenges that China faces and it's on leverage, it's on financing at the local level, it's about demographics, it's about the geopolitics. There's a lot of headwinds that we're trying to re underwrite as we speak. I can address at least demographics piece of it a little bit. Certainly there's no question China is aging and aging rapidly and their replacement rate is not sufficient so they're not having enough children. I think everyone knows this, but there are a couple of mitigants that I think at least gives China a little.
- [132:47]
B
Bit of a Runway.
- [132:47]
D
I don't know whether it's 10 years, 12 years, 15 years. But let's remember the following. China has a very low retirement age, 60 for men, 50 to 55 for women. Okay, so that can certainly move up. And when that moves up, that's the functional equivalent of with the snap your fingers. Now you have more labor force education funding has only recently, I'm talking in the last 10 to 20 years, recently improved. It's getting better. I think that should improve labor quality. So productivity is still very low relative to western standards. I'm not talking about the major cities, but if you look beyond the tier one cities, labor quality should improve. And again that's the functional equivalent of snapping your fingers. And now you have additional labor capacity. Urbanization rate has improved markedly, but it's still only 65, 67% relative to 80% in developed markets. And that means you do have a significant labor force that is still engaged in pretty low productivity agriculture. Again, if you can continue the urbanization and again that's a tailwind for labor capacity, then you layer on the big unknown. And that's around automation and robotics. And if anyone out there can send me any quality studies that predict what impact that is going to have on the traditional historical human being count driven analysis around future growth, I would love to see it. Because it seems to me that the metrics that we've used historically to look at a country and say these are the growth prospects, given the demographics, those seem they're going to be obsolete or outdated or insufficient to really give you a full picture. So I'm trying to understand, and we're trying to think about how will automation affect the growth prospects of a country that is maybe adopting it faster than anyone else on the planet. And you could probably point to China and say chances are they're going to do it faster and better than a lot of places. So the demographics issue is real, it's just math. We can figure it out. But these are some mitigants that I think give China a little bit of time afforded to address the birth rate problems. But that's only one of the concerns that you've raised on the debt side. I think it's a real serious problem. One thing China has not succeeded, and I thought it was going to happen in the last five or 10 years, was a true municipal bond market. So once they get that up and running, you're going to have more transparency and real credit underwriting around local financing and you don't have to rely on the land transactions, financing everything. There are a lot of headwinds I'm not being Pollyanna about it, but I'm thinking that there's a lot of headwinds in the US too. If we had another hour, we could list all of them and we would feel pretty morose walking out today. But still, we find great opportunities in the U.S. notwithstanding all of these challenges. China's no different. There are going to be pockets of opportunities even in this midst of challenge in other areas. So again, we're trying to keep our eyes open on the bigger picture.
- [135:56]
A
So I just want to circle back to Xi. You talked a little bit about whether Xi is reverting back to pragmatism with some recent signs and actions. Dang, as we talked about earlier, was always the die hard pragmatist. I don't think he had any ideology that he stuck to too firmly. It was very much about what worked, as you said earlier. But there's lots of views out there, opinions out there, that Xi is more of an ideologue. And I do want to balance this with the reality that Dang never had to worry about social media or mobile phones or Internet. And so surveillance is just a different question when you've got a centrally planned economy. And that I think is at least worthy of debate. But certainly he has centralized more power in this last third term. And so I wonder how the philosophy of Xi, at least from your seat, plays into your risk, reward and investment thesis as you look out with all of these opportunities. How you cannot separate investment thesis from political environment in China, as we all know. How does this weigh in as we layer on Xi's personality and worldview?
- [137:05]
D
Again, tough questions you're throwing at me today. Very fair and important questions. I can't tell you exactly how she is going to maneuver through this period of intense heightened geopolitical tension. And I'm not going to make any remarks, by the way, in this conversation about tariffs, because the half life of any tariff conversation is probably 24 hours. It just seemed pointless. But nevertheless, we can make comment and conclusions from what we observe. And when she took the third term in October of 22, it was pretty clear that this was not going to look like anything we'd seen in the last 20, 30 years in China. The counterweights all removed. Not only was it unprecedented taking the third term, but he consolidated so much power on the Standing committee on the 24 person Politburo. I think he increased what we'll call his loyalists from 60 to 80, 85%. He ignored decades old political norms that were part of the institutional stability that gave us and other investors a lot of comfort. I always like to ask people if they'd ever heard of 7 up, 8 down. Have you heard of this?
- [138:21]
A
Only through you.
- [138:22]
D
Okay, so seven up, eight down referred to the long standing protocol that when it came time for the party congress to convene, if someone was on the Politburo who was 68 years old or older, they would move down. You could only move up, so to speak, if you were 67 or younger. And this was, I think, well considered and well respected as a way to ensure that there was some vibrancy and freshness to the leadership and that certain people didn't take hold and become crony powered positions. And that wasn't respected in the 20th Congress, so that was removed. So a lot of these things I think one can observe from a distance and say, all right, maybe the rules of the game are changing. Maybe there is a new set of priorities. And then when you then listen to what some of his chief lieutenants said were saying over the last two or three years, and I think they have done a better job of coordinating in the last handful of months. But you had Li Chang, you had the premier, and you had Tai Chi, who was number five on your depth chart, if you're keeping track at home on the Standing Committee, who was chief of staff, had other major responsibilities. And the two of them were saying two different things, often out in the marketplace, about what the priorities were. And you know, the leader was not allowing them to say stuff that hadn't been approved. So you had almost diametrically opposed comments and remarks coming out of important people about, hey, the market priority remains paramount. And then you had the other, hey, this is still what our core principles are about in socialism and our priorities of the party. And the economic growth is important, but it's not paramount. Okay, so which one got approved? Many times we were scratching our heads trying to figure out which statement do we lean into. So I think there has been a lot of that that may improve. I hope it does. I don't think anyone wants to think that Beijing is unpredictable. We have enough of that in Washington, D.C. you look at Beijing, you want to have a sense of where the policy priorities are. And they've done a remarkably good job over the years in doing that with their five year plans. And they've pretty much have told you flat out and followed through on what their priorities are. But this is a moment where we feel like it's worth pausing. And as my team and I like to say, sometimes the best thing is not to do something, just sit there. So we're not just doing something. We're going to just sit here and we're going to watch and we're going to see whether the policies have an element of consistency to them from here, whether what we saw with the tech executives is an indication of a move back toward pragmatism. If that's the case, then I think you're going to see fdi. And if the US And China reach some arrangement, and I'm actually quite confident something is going to come out of that and our president will declare it the greatest negotiated accomplishment in the history of humanity. And there's going to be something if that gets resolved and Beijing has more consistent set of articulated priorities, then I think the juice is there again. But for the time being, we're going to sit back and try to be patient about it.
- [141:46]
B
I'm disappointed to hear you don't want to talk about tariffs because I have to scrap my next five questions. But in all seriousness, you talked a little bit about the policies in China, but then there's the geopolitical element of this and in particular the US and you answered part of the question I was going to ask here on is something that's going to happen in the next couple of months between both countries. And I would love for you to talk about maybe some of the things that you're looking for in the meantime while you're sitting and waiting for something to happen. And then maybe more of a broader philosophical question. But with Biden putting some of these policies in place, Trump continuing some of those policies, what is the thing that we've learned through all this and things that we should be learning in terms of balancing national security interests with more economic competition, market participation and so on?
- [142:38]
D
Well, I think if you look at the China relationship, it's one of the few things in Washington, D.C. where it appears there's consensus. We have a competition going on. We have a need to focus. This is about national security. It's about winning. That's the repeated refrain we hear out of Washington, D.C. i think some of that is now misguided. This is not a finite game. This is not a situation. We're in a fourth quarter and there's four minutes left on the clock. This is not a zero sum game to some degree. This is about figuring out a path forward where both countries can survive and succeed and collaborate in important areas. And I think that a lot of the headlines are incredibly enticing about the drama around this. But I think this too shall Pass. And I think we'll ultimately get in the place where there is cooperation again. Now, all that said, I do think it's also fair to say we are in a new period of what some have called modern mercantilism. So what do I mean by that? I think the period of unfettered globalization, of unfettered global trade, I think those days are gone. I don't remember ever reading Milton Friedman in the 60s, published an article where he said, we're all Keynesians now. We're all Keynesians now. We're all learning how to utilize fiscal deficits to manage business cycles. Perhaps we're all mercantilists now. Perhaps that's the case. Maybe we're all now in this for a long period of time where there's going to be, instead of the classic mercantilism where countries were accumulating gold and silver through trade, maybe we're now about accumulating wealth and strength through industrial policy. Maybe this is a period where there's going to be more protectionism, there's going to be more focus on supporting domestic industries and restricting some competitors for the very specific purpose of national security and for developmental security, which is a term, by the way, that Xi Jinping has used over the last four or five years, developmental security. And in his context, it was like, hey, you guys have cut us off and went after Huawei pretty hard. You cut us off with access to chips. That's like cutting off oil. So I think we could be in a new moment where these features of modern mercantilism are just something we're going to have to get used to. And that just means more government intervention. And I'm not talking necessarily about orchestrating the economy, but certainly having an industrial policy that'll promote important features of the economy and maybe some national corporate champions. China has been really good at that. China's been really good at that. The US if you want to make someone laugh in the us, you say, hey, I'm from the government, I'm here to help. But in China, you got to tip your hat and just give you an example of how they've been good at industrial policy or technology, industrial policy, whatever I'm going to call it. Remember, they kept Amazon out, they kept Google out to allow Baidu and these other national champions to really flourish. And Uber had its day in the sun, but then they got ran out of town as well. So what did China do? China created this Galapagos island type of thing where there weren't any natural predators to their little domestic companies allowing them to grow and flourish. So China has been really good at that. The US isn't particularly good at that and we haven't been historically. So I think there's a little bit of catch up. I'm quite certain the pendulum is going to swing back too far the other way and there could be a lot of pain associated with that. But this whole concept of mercantilism is maybe here to stay. So maybe we are all mercantilists now, but it's going to be a more difficult challenge because in the past it seemed to me that geopolitics was a tail event that you thought about when you were underwriting a foreign investment. But now it's like front and center. You're looking at technology flows and supply chains and you're trying to think about all of these layers of potential risk, which of course mean your expected returns have to compensate you for these expected risks. So it's not a surprise to me, given all of that, that a lot of US investors just say to their and their investment committees say what are we doing? What are we doing outside the US and why don't we just bring it all home? And I think that that is probably going to be a trend we're all going to watch unfold in slow motion. Home country bias is going to return back to the levels we used to see in the 60s, 70s and 80s. And I think DAS allocations in many, many institutions are going to reflect that and that's just going to be a function of it was just too hard to underwrite at all.
- [147:23]
A
So is the Galapagos approach code for make China great again? Is that what you're saying at Is.
- [147:29]
B
That where we stole that fit on a hat?
- [147:32]
A
Ed, I want to close with maybe asking you to be a bit of an oracle, a counselor for many of your contemporaries that sit in your seat at public pensions and university endowments. Because the beauty of the way Bill and you have set up and led the foundation has given you a lot of independence and autonomy on managing the portfolio and others don't have as much of that luxury. And so a lot of these sustainability moral esg you might call it challenges start to chirp and provide pressure in times when there are questions about differences of morals or human rights, et cetera. How would you advise CIOs that are struggling with that in weighing both the long term China approach that you have been a proponent for for decades and some of these short term challenges that maybe are part nativity and partly well grounded?
- [148:25]
D
I'm Absolutely not going to criticize any investment committee that says, listen, we just don't want to invest in China because I think reasonable people can disagree about whether it's better to engage because there's a lot of good things that happen from engagement, or whether we should just pull up our tents and let's go. So that's a threshold question that any institution should answer. And again, reasonable people can reach different conclusions. We've always felt like engagement was a far better path for a host of reasons. But your question about governance and going in front of an investment committee and talking about China, that's a real challenge today. It is a real challenge. And One thing that CIOs don't like to talk about unless over a glass of wine and they're sure they're not being recorded, is career risk. And it affects behavior and it affects how CIOs thinking about sticking their neck out in an investment committee where two or three or four people say, well, the headline I just saw on the way in here said, and they just don't want to go into battle and have to defend a strategy like investing in China at every single board meeting because it just is exhausting. But what the consequences are is sometimes that pushes a staff toward a more conventional asset allocation approach that mirrors other investors. So rather than really a long term strategy that might deviate from the short term benchmarks and may actually produce alpha but require explanation every meeting, they'd rather become closet indexers. And that's a career decision that I'm not going to malign. But I think that that happens probably more than most are willing to admit to some degree. But I think a lot of CIOs know that China is a hard underwrite right now, but boy, it could become unjustifiably cheap in short order. And if some of these unknowns get known, it would be hard not to think about it. And we talked a lot about the headwinds. The tailwinds remain. It is a special place. And as the saying goes, China is the only next China. I do think that Xi is showing signs of that pragmatism. We want out of self interest, by the way, not because he's had this epiphany, but out of self interest. And China VC is probably the least crowded trade in the world right now. So I think CIOs are going to be struggling with that. And I'm sure some will lean in and those will be the ones we'll either toast in five or eight years as being brave or we'll see him on a street corner holding a pan saying, will asset allocate for change? We'll see.
- [151:06]
A
Well, that's great wisdom to close us from, I think, the top performing ENF CIO over the last 20 years. So you're right, there's a fine line between intrepid, one of your favorite words, and absolutely crazy. And sometimes it's just a thin line, the width of a hair that determines which side of that line you're on. So, Ed, thank you for such a fascinating, wide ranging conversation. We really appreciate you helping us think through this and listeners, stay tuned for the Last Sip. Well, welcome back to the Last Sip. Aaron. I feel like I need to go to the spa for some recovery time after that length of a workout is what it felt like, intellectual workout nonetheless. But it was long, it was dense, it was heavy, and it's complicated as we opened the whole episode with so I guess I promised in one sense we weren't going to get too normative. But I'm going to break that a little bit and just ask you where you landed. I mean, you heard from Ed, you did a lot of research yourself. You heard my soliloquy on history. Where are you in balancing all these elements?
- [152:12]
B
Speaking to the length, John, if William Ma is still working out, he's going to be swole the next time we see him in person. So I'll park that there. Yeah, I think where I landed on all of this, maybe to my comment in the very beginning, it is complicated. I think that for someone like me who I have a longer time horizon to my investment horizon, I've got a pretty high risk tolerance as well. The innovation story I think is really compelling. And so if you can withstand some of the volatility that's associated with investing in this part of the world, you know, as Ed said, and I think you might have said, John, in the conversation, China's doing a lot of things better than we are and getting access to that, if you can, to play offense in your portfolio is really compelling. Now obviously there's a lot of risks that are associated with that that we walk through, but if you can withstand that, I think the general direction looks pretty positive. So again, I've got a lot to learn on this. I've learned a lot in this process, but maybe the naive, slightly more informed version of myself, that would be my answer for the time being. How about yourself?
- [153:20]
A
Well, I think as you've just said, it is a massive contradiction right now. That makes it very challenging. So on the one hand you have this explosion as we tried to talk all the listeners through of this expansion of innovation opportunities and an inventory of now new industry in the new economy that they are leaders in. It is well beyond, as I said, Internet services and E commerce where they started. So a lot of the global innovation and market leaders are coming out of China. At the same time you're getting economic slowdown and fears of clampdown from political operatives and leaders. And so that reconciliation is what makes this challenge so hard. Do you need maybe is a good question, all three of those to be going in the same direction. I think your point on time horizon is absolutely critical. I'm reminded of, and if Steve Kistner's listening, forgive me, Mr. Kistner, I'm going to tell a story on you, but my very first job in the mid-90s is at state street bank and Trust. So it was old Boston money, crunchy old trust officers, and Steve had one of the biggest books. Mr. Kistner, I should say bow tie, old school Bostonian was a great mentor to me, very kind and he gave me completely naive 22 year old me this task and opportunity to go find a stock pitch for his portfolio. And I remember coming back and part of this is my own emotion and preferences. But I came back with Hasbro, who had just won a big Star wars franchise rights and seemed destined for significant earnings growth. Mr. Kister listened to me and then he just kind of laughed and said, you know, what do you want to call my clients when Hasbro goes poorly or when Disney goes poorly? And this is the old it's not a difficult conversation if you own IBM. This is that old adage. And I think China is very similar. There's a ton of career risk here. I think a lot of CIOs worry about the engagement with the board if things go sour. When all of this risk, as we've talked through at length, is very clear. And so I do think, using Ed's word, that you have to be intrepid and long term and be willing to, as you said, accept a whole lot of volatility and maybe even fear of the unknown. But China's not going away. In fact, they only seem to be accelerating their leadership across a lot of these areas and expressing their might as we talked about across the world. And so it's too big to ignore is what sometimes you say. And I think that's wholly appropriate here. So that's my view.
- [155:50]
B
I agree, John. And I think it's different when you report to yourself versus when you report to a board or you report to a client. And I think the whole career risk, or frame of reference risk, if you will, is if we're US Investors, there's a natural gravitation to pay attention to US equities or US Assets. And when we work with clients, the international story was very compelling. Valuations are great. There's all these things you're pointing to, but the US kept chugging along. And it's much more difficult when your international Portfolio underperforms your U.S. portfolio when the S and P is down. People understand that. But I take your point. I think that's absolutely right when you're reporting to clients, to boards who are paying attention to what the US media is saying and what US markets are doing. So, yeah, agreed.
- [156:36]
A
So our funny question to close us off today that we agreed upon was, Aaron, you are a fashion forward type of guy. What fashion trend would you bring back if you had the ability to do so?
- [156:50]
B
I don't know if I'm a fashion forward type of guy, but I'll take that at face value. John, thank you. So, because she can't defend herself right now, one of our producers, Paulina, is in the background, Gen Z, and was talking about the cringe nature of fashion in the 2000s. So maybe just to be vindictive, I would say the 2000s fashion is what I want to bring back. Big baggy jeans, pop collars, maybe some skinny jeans here and there. The emo bangs. I'm here for it. It's terrible. We're already starting to see it, but I'm bringing that back. How about yourself?
- [157:23]
A
You know what? In fifth grade, I had the coolest pair of parachute pants ever. Pleather, fake leather. They'd be horrible in a professional setting, but it'd be so much fun to bring those back. You talk about cringe. I'm an 80s homer, but, man, some of the fashion stuff, I mean, even I struggle with understanding how in the world I looked in the mirror that morning and went, you look pretty good. I'm going to wear this. But, yeah, I'd like to have an executive retreat where we all wore parachute pants. I think that would be a fascinating social experiment. So there you go, John.
- [158:00]
B
I think when we promote this episode, we should find that fifth grade picture and use that as the promotion, because the listens will skyrocket. That's awesome.
- [158:08]
A
I'm sure they would. All right. With parachute pants out of the way listeners, I'm not sure how that connects to our journey through China's history. I won't even attempt that one. But thanks for bearing with us. I hope you learned as much as we did. We had a wonderful experience through this and as I said, this is an episode of great pride because of the importance and all the different elements and complications. So hope you enjoyed it as much as we did and we will see you on the next episode of Capital Cool To Can.