Investment: The Case for a Low-Volatility Approach

Introduction: Since late September, the A-share market has surged spectacularly with the introduction of a series of significant policies. However, many overlook that such a rapid rise may lead to increased volatility in the market, and high volatility is often the enemy of profit for most investors.

As the famous line from the American series "Westworld" goes, "These violent delights have violent ends," excessive upward fluctuations can trigger downward swings. Given that investors, as a group, find it hard to gain excess returns through timing (especially when taking transaction costs into account, timing typically results in negative outcomes), a highly volatile asset can easily prevent most people from making a profit.

From the perspective of achieving investment returns, low volatility is key. While this aspect may not be frequently mentioned in the current bull market, historically, more and more investors have sought products that deliver a steady upward trend. After all, who wouldn't appreciate a consistently rising net value curve?

So, how can we guide investors to products with lower volatility that still provide reasonable returns? We believe that this requires support from two levels of factors:

First Level: The asset itself must possess characteristics of lower volatility. No matter how excellent a fund manager is, it is difficult to continually reduce volatility in a naturally high-volatility asset.Second Level: The fund manager’s capability to strive for absolute returns. Even if the underlying assets are of lower volatility, the fund manager needs to demonstrate alpha capability. This became increasingly important, particularly with the large-scale emergence of ETFs.

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Looking at the historical performance and volatility of major asset classes, A-share equity assets exhibit one of the highest annualized volatility rates among all primary asset classes. From 2003 to 2023, the annualized volatility of the CSI 300 Index was over 25%, while the annualized return was only about 6%.

This explains why, after repeatedly being "tortured" by the high volatility nature of A-shares, investors especially need to identify lower-volatility "smoothing" fund products.

We found that Dong Chen and Zheng Qing from Huatai-PbR are a team managing a combination of equity and debt products that exemplifies this "smoothing" strategy. Their jointly managed products, Huatai-PbR New Benefit Mixed and Huatai-PbR Dingli Mixed, have recorded positive returns every year since 2021.

Such performance doesn’t lag behind the long-term annualized gains of major equity market indices, yet the corresponding volatility may differ significantly. Their products use inherently low-volatility bonds as the underlying assets, combined with equity assets to enhance flexibility, fully leveraging the seesaw effect between stocks and bonds. More importantly, both fund managers have demonstrated a capability for excess returns in the past few years, making their team one of the standout stock-bond combinations in the market.

Outstanding Stock-Debt Combination with Excellent Historical Performance

Since 2020, various main bond, less stock strategy products have been launched, and through this process, we have interviewed numerous fund managers of different types. We discovered that their approaches to achieving excess returns differ significantly. Some fund managers excel at stock selection, while others excel at asset allocation, convertible bonds, or rely on team collaboration.

However, objectively speaking, the main bond, less stock strategy has been challenging in recent years. Due to significant fluctuations in equity assets, especially after 2021, achieving positive returns has become increasingly difficult, resulting in periodic corrections for many such products. Anyone who has engaged in asset allocation knows that a 20% allocation to equities can significantly impact the entire product's risk-return profile.

In contrast, the historical positive return "gold content" of the products managed by Zheng Qing and Dong Chen is notably high. They achieved positive returns even in the challenging market environments of 2022 and 2023.

One of the greatest enemies of long-term returns is drawdown; if a product declines by 50%, it must double to recover. With their shared history of achieving annual positive returns, the performance rankings of the products managed by Dong Chen and Zheng Qing are among the top in their category. Based on data from Galaxy Securities, Huatai-PbR New Benefit Mixed A ranked 3rd out of 122 similar products over the last four years.

Dong Chen on Offense, Zheng Qing on Defense

A significant part of the value of main bond, less stock strategy products lies in asset allocation. From the perspective of enhancing the risk-return ratio, a bond-heavy and equity-light asset allocation may naturally enhance the combination's risk-reward profile. This is because stocks and bonds can often serve as hedges against each other; historically, during years when the CSI 300 Index fell, the CCSI All-Bond Index generally rose.

The dual manager combination of Dong Chen and Zheng Qing also effectively harnesses "asset allocation." Zheng Qing excels at defense while Dong Chen focuses on offense, creating a naturally complementary partnership.

Zheng Qing is responsible for the bond portion of the product. From 2007 to 2023, China's short-term pure bond fund index has achieved positive returns every year, with only three years (2011, 2014, and 2016) experiencing drawdowns exceeding 1%. Such characteristics made the bond component a solid foundation for the product.

On the other hand, bonds exhibit characteristics of asymmetric risk compared to stocks. Once a purchased bond encounters default risk, the potential return is limited, while the losses can be substantial, akin to a selling options model. These attributes greatly enhance the defensive nature of bond investments.

In constructing the bond portfolio, Zheng Qing focuses on managing three major risks:

1) Credit risk. Avoid credit downgrades and communicate a well-established internal credit assessment system.

2) Interest rate fluctuation risk. Strictly control the duration and leverage of the bond portfolio, avoiding high-risk returns.

3) Liquidity risk. Build multi-layered liquidity reserves based on leverage, interest rate bonds, bank capital bonds, and high-grade credit bonds to maintain good liquidity in the portfolio.

Additionally, managing high-liquidity bond funds requires sufficient attention to detail. As the saying goes, "Big money requires fine thinking." Zheng Qing's meticulous and cautious approach has also laid a solid foundation for the product.

We believe that anyone who observes Dong Chen's net value curve will be astounded. Even with a substantial increase in scale, his proficiency in rendering a smooth performance has not diminished at all.

Dong Chen is not only capable of offensive strategies; he also exhibits commendable defensive abilities in dealing with volatile equity assets, which further supports the volatility control and return goals of the main bond, less stock strategy products. His investment acumen has also yielded satisfying results for the holders in the challenging market conditions of recent years.

So how does he achieve this?

In an interview a few years ago, Dong Chen mentioned his investment framework: focusing on the quality of the company, the economic cycles, and growth potential to make value-for-money switches. This encapsulates two keywords of his investment system: 1) Value for money; 2) Switching.

When selecting stocks, Dong Chen does not present a distinct single style; instead, he considers various dimensions and seeks stocks that offer overall good value. His ability to outperform the benchmark consistently across different market environments ties back to his investment philosophy centered on comprehensive value for money.

Despite the expansion of the management scale, the trajectory of his net value curve has remained unchanged, indicating that Dong Chen's investment system remains effective in the new market conditions. When holdings appear overvalued, he makes adjustments based on value-for-money considerations. His overall investment approach leans towards offense through defense, striving to maintain the "anti-fragility" of the portfolio regardless of extreme market risks.

This investment style has positioned Dong Chen as a representative of the "smoothing" strategy in the market.

Zheng Qing focuses on defense while Dong Chen handles offense, making them exemplary partners in the field of main bond, less stock strategy.

Guarding Wealth is Becoming More Important

According to statistics from the IMF, China's per capita GDP exceeded $10,000 for the first time in 2020, indicating that China is gradually transitioning from a developing country to a more developed nation, and citizens have accumulated a certain amount of wealth over the past few decades of rapid growth.

As household wealth accumulates, safeguarding this wealth has become more crucial than ever. There are two key points to guarding wealth:

1) Avoiding losses. Today's losses hurt more than they would have a decade ago; accumulating wealth takes time, while losing it can happen in an instant. Especially as one ages, recovering lost wealth becomes increasingly challenging.

2) Avoiding disguised depreciation. Beyond maintaining a loss-free bottom line, wealth should achieve some level of growth that at least outpaces inflation. If an investment consistently fails to beat inflation, the investor is effectively incurring losses.

Against this backdrop, main bond, less stock strategy products with both offensive and defensive attributes have gained even more significance. Especially those that can effectively protect against lower-return thresholds in volatile markets while capturing yield elasticity during bull markets. Clearly, the products managed by Dong Chen and Zheng Qing embody this dual capability.

Recently, their new dual-strength secondary bond fund, Huatai-PbR Jili Bond (Class A code: 022016; Class C code: 022017), is in the process of being issued. For investors reluctant to bear high market volatility yet hoping for returns with a degree of elasticity, this might be an excellent choice.

As we mentioned at the outset, when viewed over the long term, the eternal returns of equity assets may not be as high as many believe, while the associated volatility costs can be substantial. Tempering return expectations and opting for a product that offers a more balanced yield-to-risk caliber might be a more reliable strategy to win in the investment marathon.