What An Ancient Chinese Board Game Can Teach Us About Investing In Frontier Markets


Since our Mongolia Meet Up Chris and I have been fast and furious. Over the last week we’ve published posts on both Laos and Cambodia, which we previously covered in-depth with our friend Doug Clayton from Leopard Capital.

For those who may have missed his musings, Chris just returned from a road trip that took him from Chiang Mai, Thailand to Vientiane, the capital of Laos, on a visa run with the wife and kids in tow for hours, and hours and hours in a tiny rental car…followed by more hours standing in a queue…ahhh, the fun he has!

Within the next few weeks we’ll both be headed to Myanmar to investigate opportunities first-hand on the ground with a few of our colleagues, and likely some new friends. If you happen to be in or around Yangon the 10th-15th, let us know and we’ll make sure to meet!

Following Myanmar we’ll be headlong into our planning for our next investor Meet Up, which will be held in Savusavu, Fiji in November! The cat’s out of the bag now, so keep the first couple weeks of November free! We’ll get you all fully up-to-speed on the final dates, the agenda and our logic for choosing Fiji over the next couple of weeks, so stay tuned.

Meanwhile, and as a result of where we currently find ourselves planted (Southeast Asia), I’ve been thinking a bit about why we invest so heavily in the Frontier Markets. As is usually the case, the universe quickly provided me with some fodder with which to contemplate the subject matter.

I came across an excellent article on ZeroHedge by Mark Spitznagel, the founder and Chief Investment Officer of California-based Universa Investments LP.

The subject of the article was Ron Paul, and how, in Mr. Spitznagel’s opinion Congressman Paul has used the ancient Chinese philosophical and military strategy known as “shi” to forward his agenda over the years.

After reading the article I thought that I could also use the concept of “shi” to explain the rationale for investing in Frontier Markets. You can tell me whether or not you think it makes sense.

As Mr. Spitznagel so eloquently explained, “Shi (pronounced “sure”) has no single, obvious translation, though the best seem to be strategic-or positional-advantage, or potential energy. We might call it cultivating the influence of the present on the future. Shi has been traced back as far as Laozi and the Daodejing, the fourth century BC political treatise attributed to him, with its counterintuitive processual and indirect approach to conflict.

“The quintessential metaphor for shi is water, flowing ever downward in the most naturally powerful and effective way, ultimately overcoming everything in its path. Paradoxically, it is one of the softest and yet strongest forces in nature.”

He then uses the example of the ancient Chinese board game, weiqi (pronounced “way-chee”) to illustrate a lesson that I think fits perfectly with our investment philosophy. Read on…

“Shi’s antithesis, li, is the strategy of decisive victory in each present battle, typically a more natural, comfortable, and coherent approach than the greater subtleties of the shi approach. While li is seen as a very western world view, it is that forward-looking strategic-advantage orientation of shi that has been the basis of the advancement of western civilization itself—from capital investment and production to the ceaseless pursuit of innovation.

“Throughout history, perhaps the clearest and most pedagogical example of shi at work has been in the Chinese board game weiqi. In this simple yet most complex and calculated of games, opponents (one with black stones and the other with white) each try to surround the most territory on a square grid. The obvious initial strategy is to dive for the corners (the easiest territory to surround) in pursuit of immediate points. The extreme example in this picture shows that li strategy’s allure yet great disadvantage.

Go board
“White is far ahead in terms of tangible territory right now. But black has established a strategic advantage and intangible edge by moving into the center to command the rest of the board. Black, employing the indirect and circuitous shi strategy, seeks future opportunistic potential, rather than applying direct force like the chess player bent on annihilation. Although white has scored at least 13 points out of the gate, and black has scored nothing, black is well-positioned for an eventual, but patient victory.”

How does this apply to investing in Frontier Markets?

Like in the weiqi strategy above, I think investing capital across “the board” in various markets that are currently in their infancy, and most often overlooked allows us to gain a strategic advantage over those who lump all their capital into one (developed) market, e.g. the US capital markets.

By spreading our risk and placing our capital where it is most needed and welcomed, in markets where the growth is just getting started, versus stagnating, we are setting the stage for outsized future returns when those markets become fully-valued.

Using the example of water flowing to where it encounters the least resistance, taking its natural path, our investment capital flows easily to where it also encounters the least resistance and can enjoy the highest returns.

This should occur naturally and instinctively for an investor, alas it is not that easy. Avoiding risk is also built into our nature as human beings.

By yielding to our fears and resisting the intuitive, natural ebb and flow, we inadvertently take MORE risk. This occurs despite our belief that we are minimizing risks by playing it “safe”.

Are the Frontier Markets as “risky” as some would have us believe? Sure they are, if you approach it like an average investor.

With the year more than half over, the top 10 Frontier Market equity indexes have gained more than 18 percent, according to Bloomberg.

In fairness, that’s almost exactly what the Nasdaq has returned this year. Looking at it as an “apples to apples” comparison might lead you to believe that all is equal. However, this is not the case.

Following averages and investing in index funds will lead to “average” performance. Most of the large, Frontier Markets-focused funds only invest in the larger, more liquid bourses. They buy the largest companies with the most liquidity. This strategy is obvious for a portfolio manager…it’s easy. No offense to any of you PM’s out there, but you know what I’m talking about.

What’s more difficult is finding the outperformers. Take Pakistan as an example. The Karachi KSE 100 Index has gained almost 25 percent this year on the back of a reduction in the capital gains tax, “cheap” stock valuations and strong corporate profits. Pakistan?

To be able to identify the markets that have a tailwind and are likely to outperform, you have to be out there turning over the leaves.

Chris and I take it a step further by investing our capital into private equity deals in Frontier Markets.

It’s a bold strategy, and certainly it comes with commensurately more risk…much more, but also more reward!

Our returns range from -100% (yes that’s a full loss of our capital) to thousands of times our initial investment. If we diversify sufficiently, spread our capital out, perform the necessary due diligence and surround ourselves with smarter folks than we, then the risks decrease substantially…but they never disappear.

Like the calculating weiqi player, over time our “diversification strategy” will result in some losses, but in the end we are confident of our victory. Contrast this to the investor who deploys his or her capital into “corners”, where it is considered safe and can theoretically weather a storm. How is victory achieved that way? The losses may appear to be manageable, but the resulting “average” returns won’t allow you to “win the game”, only bold action combined with calculated risks can achieve that goal.

This is what we do with our capital. It’s not for everybody, but if you’re an accredited investor and you want more information on how Chris and I play the game, click here.

– Mark

“It seems to be a law of nature, inflexible and inexorable, that those who will not risk cannot win.” – John Paul Jones

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