Cut The CUB!
The niche The CUB (China Under Biden) was closed last Thursday and its stocks sold on Friday at the opening. Here are some considerations.
The logic of the niche
The CUB is a Niche launched on the first day the markets opened in 2021. It consisted of a portfolio of stocks whose objective was to gain exposure to China through solid, reliable companies with very depressed valuations, in order to benefit from an improvement in US-China relations, which have come under severe pressure during the Trump administration. The companies were largely infrastructure-related and exposed to the One Belt One Road project, once a hot investment topic and now forgotten, although its medium-term relevance has only increased in recent years.
Valuations and portfolio reliability
Stocks enjoyed very attractive valuations, with valuations of 2/3x EBITDA, 6/7x earnings against a solid capital structure. On top of that, almost all stocks were state-owned (SOE), which made them reliable in terms of balance sheets and political support.
What worked
Thanks to the political support, the portfolio was not affected by the ongoing campaign to “re-direct” some sectors. In addition, the rift with the US has made the continued management of political alliances, one of the objectives of the One Belt One Road project, more important. This has allowed the portfolio to appreciate despite the negative environment. Since its launch, the Niche has performed positively by 30.4% versus -4.1% for the Hong Kong HSI (both figures are shown in total return and in euro).
Performance of THE CUB vs Hong Kong (HIS)
What didn’t work
The expected softening between the US and China following Biden’s rise to power did not happen. Chinese stocks forcibly delisted from the US market have remained so and their complete divestment by US investors remains mandatory by November.
Why sell?
From a valuation perspective we see a likely further significant portfolio rerating over the next two to three years. Multiples remain low and news flow should be supportive for these companies. However, the Chinese political situation remains volatile and difficult to read in the short term and we find it more attractive to take profits here and redeploy resources into areas with even lower valuations and an improving political climate. Nevertheless, it is possible that this will only be goodbye.
Where do we reinvest?
We are reinvesting liquid assets (5% of the fund’s NAV) by increasing the space, from 5 to 10%, in the Japanese Orphan Companies Niche, which focuses on Japanese companies not covered by analysts and with certain characteristics. We will devote the next commentary to this niche.
Equity tardigrades
Tardigrades are millimetre-long creatures that can survive for a decade without food or water, at temperatures approaching absolute zero or well above the boiling point of water, at pressures six times greater than those on the ocean floor, in the absence of oxygen, at very high levels of radiation, and even for long periods in space. 
They are so resilient because they are able to repair their own DNA and reduce their body water content to just a few percent. Under extreme conditions these animals suspend all visible metabolic activity.
On the stock market, the companies that certainly stand out as resilient are the small Japanese companies that have been listed since before 1990. These companies have survived 30 years of crisis in the Japanese archipelago and have therefore developed unique characteristics. Among these companies many are just forgotten, i.e. not covered by analysts. We are talking about almost 3,000 listed companies that are accustomed to doing without analysts’ coverage and thus to foreign investors. Here we find mostly companies with a capitalisation that varies between 100 mln and 1 bln USD. Of these, looking at those with adequate trading, more than 700 have a capitalisation/tangible equity ratio of less than 0.8x and net cash of more than 50% of capitalisation and it is this part that we focus on. We are talking about companies that are generally profitable and have been in the market for a long time. Clearly, far from being fashionable companies, they are exceptional companies, able to withstand the blackest crises thanks to flexible business models and bank-like balance sheets. Small and very tough. The true tardigrades of equity!
From this beautiful pool we select stocks for the Orphan Companies Niche and with the selected companies we start an engagement process aimed at improving their sustainability policies. The work is very interesting and the results of the engagement extremely positive.
We see very significant upside here, with downside risks limited by the wealth of these companies’ assets, their ability to generate profits in extremely difficult times, the reliability of their accounting records, their great professional skills, their exposure to foreign markets where many have expanded, a gradual change in governance, better attention to investor communication and a legislative dynamic that favours dividend payments. A gradual return to the physical infrastructure on which many of these companies are focused is a potential catalyst, in addition to the arrival of long-overdue structural policy reforms in Japan.
“If slaughterhouses had glass walls, we would all be vegetarians”.
We quote Sir Paul McCartney’s famous phrase here as a headline, which we believe has been overlooked by investors. There are some avoidable and unpredictable revolutions. And there are revolutions that are inevitable and predictable. They do not seem so because they are slow. Man is a dynamic creature: he must do, see, feel, rejoice. He is not inclined to wait.
The demise of the meat industry is written. As is that of tobacco or oil. Those born today will consume less of it. It is not out of the question that our great-grandchildren or even grandchildren will wonder how it was possible to raise and slaughter mammals and then eat them. To them it might even be repulsive. Like us eating a fried cockroach, delicatessen in Thailand. The change might take 50 years or, in the world of Big Brother, as little as five. Furs were criticised for 50 years without much effect and then within 10 years, due to the relentless work of activists, they almost disappeared.
There are too many negative elements against meat: 1) It will become less and less acceptable that mammals are treated cruelly. In the Middle Ages animals were an important resource and were treated with more respect than today. Today they are just consumer goods to be bred and slaughtered industrially. Let’s not talk about what they do in China… Where is the coherence in a world seemingly increasingly concerned with suffering and injustice? The consistency lies in the fact that the industry is powerful and buys a lot of publicity and the ugly images of what goes on behind the scenes are not made visible. But they will be more and more, and that mouthful may become hard to swallow, with serious repercussions for companies in the industry. 2) Mammal farms are responsible for almost 20% of greenhouse gas emissions and therefore have a major influence on global warming. 3) The use of water and land related to mammal farming is enormous and could be used to produce much more plant protein and defeat malnutrition in the world once and for all. All three points point to declining political support for the industry.
Investment in finding alternatives that are more ethical for animals, less harmful to the climate and more respectful of those who have less to eat is increasing significantly. The results are astounding. We highly recommend a series of articles in the last edition of the Economist on the subject. Technology can help deliver cleaner, greener delicious food | The Economist The future is sealed. So what to do? a) Do not invest in meat producers or, if you do, bear in mind that it cannot be a long-term investment b) Invest in companies exposed to alternatives to meat.
To confirm what we are saying, the meat bigwigs are among the biggest investors in companies offering alternatives to meat itself.
As we understand the trend ahead of us, we would like to offer our investors exposure to products/companies that can benefit from this colossal shift. However, we have a value approach and at present the choices are limited but not nil. These are the options:
1) Companies producing plant proteins. There are companies that aim to offer an alternative to meat and there are companies that want to offer the same experience as meat using plant-based ingredients. Here, pure listed companies are few and far between and too expensive (for a value investor). However, there are conglomerates that have divisions here that may need to be spun off and can create value with limited risk.
2) Companies producing protein from insects (which in the West can be used to feed domestic animals and for aquaculture). This is an area with great potential. There are no ethical or environmental issues here. There are no pure listed companies and if there were they would probably be very expensive. Exposure can be gained through food companies that have invested in start-ups in this area.
3) Companies that produce meat in the laboratory, through stem cells, without the need to breed and slaughter animals. The same applies here as above.
4) Companies operating in the field of responsible fishing and aquaculture.
5) Any company offering products and/or services that can serve the above companies.
A trillion euro industry could be wiped out. Each destruction brings with it great opportunities …
This week the results of the big US banks start to come out and, as usual, they anticipate the rest of the market. We are confident that they will report decent results and thus help investor sentiment. If so, we expect European and Asian banks to respond well. We expect a sanguine market towards growth stocks: those that report well may go even higher, but those that report poorly may be punished mercilessly. At these levels we expect a little more leniency towards value stocks that report badly, and a lot of enthusiasm if they do not.
Log Book
The recent market shakeout could be all the more positive and create a bit of a vacuum to end the year on a positive note. The sellers of recent weeks will have no choice but to leave much of the sell-off in cash. 
This, if the market does not collapse, will gradually be put back into the market on the rebound, giving strength to break through the various resistances. This is particularly true for the most valuable indices. Let us remember that the market can rise with very thin volumes; the only conditions required is that there is liquidity around, few sellers and a little of that thing that in Anglo-Saxon countries they call FOMO (fear of missing out), that is the anxiety of missing the market train. And the risk of missing out on a (little-awaited) year-end rally here seems absolutely not to be underestimated.
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