Introduction：October 8, 2022 is the 7th anniversary of DCL Investments. Here, we would like to share an internal letter from Ms. Zheng Hualing, the director, to all readers who care and support DCL Investments. The content covers our cognition and thinking about the trend of the distressed asset investment industry and the development of our company, accumulated within the seven years of deep cultivation in the distressed asset industry. The continuous success of investment is inseparable from the continuous improvement of cognition. And only the institution with determination and ability to build long-term core competitiveness is expected to stand out in the 2.0 era of distressed asset investment.
Dear colleagues and partners of DCL:
Greetings! Autumn is getting stronger. On behalf of DCL, I would like to express my best regards to you and your family. May the whole family be safe and healthy. In an instant, the bumpy 2022 is about to enter the closing stage, and DCL also celebrates its seventh anniversary today. In the field of distressed asset investment, since its establishment on October 8, 2015, DCL has gradually entered the growth stage from a new entrepreneurial institution, striving to create relative certainty for investors in this uncertain environment. At the same time, our team is also constantly learning and thinking, seeking development under the premise of stability.
Since the beginning of this year, it should be said that everyone, no matter what industry or market position they are in, most likely have a brand-new understanding of the words “difficulty”, “challenge” and “uncertainty”. From the geopolitical conflict that started at the beginning of the year, to the outbreak of COVID-19 in Shanghai in the second quarter, to the sharp fluctuations in the exchange rate caused by the Fed’s continuous interest rate hikes in the third quarter, major events emerged one after another, and the stock and bond markets have also experienced continuous fluctuations and high volatility. How to deal with the situation and make certain adjustment is a realistic task in front of every asset management organization.
Over the past few years, we have maintained close communication with investors, industry partners and peers. An interesting little detail is that when people meet colleagues of DCL this year, the common first reaction is to ask: “It is becoming more and more difficult to invest in this market, but the more this environment is, the better your business should be? “Indeed, we really feel that the market attention in this segment of distressed asset investment is constantly increasing. As an investment institution that has been focusing on the front line, this is certainly the time window for us to keep our eyes open and aim at the target. But at the same time, we must always be in awe of the market, and we must observe, track and deduce the trends of the market over and over again, and make convictions before moving.
Face the opportunities as well as the challenges, consolidate core capabilities and embrace core assets
For professional investment institutions, most of the return comes from the realization of their own cognitive level. The perception of macro cycles, industries, and specific targets is the core of excess returns achieved by all investments, including distressed asset investments. Standing at the current time point, what kind of cognition we have will determine whether DCL can still go steady in the next five or ten years, and grasp the opportunities of the industry.
From our perspective, the threshold for participation and profitability in distressed asset investment is further increasing, and the 2.0 era of China distressed market we have been emphasizing is well and truly here. In the early ten years of market development from around 2000, the profit sources of distressed asset investment were still mainly information asymmetry and periodic opportunities in the ultra-prosper business cycle of real estate. Now these two basic assumptions have undergone fundamental changes. First of all, with the substantial increase in the supply of various distressed assets, increasingly diverse practitioners, a steady flow of talents, and the advancement of regulatory policies with the times, the industry is making great strides in the direction of marketization, standardization and transparency, and the low-dimensional arbitrage space is getting smaller and smaller. Secondly, the gradually developed leading platform, with its own institutional, large-scale and ecological capabilities, is more conducive to the steady development of such institutions in the complex and changeable market environment, while not missing short-term trading opportunities, but also deploying long-term strategic themes.
Therefore, if investment institutions in distressed assets want to continue to make profits in this market, they must be able to continue to iterate and update themselves, and constantly build their own core capabilities. In addition to the necessary judicial disposal capabilities, the core capabilities should also be reflected in:
(1) Systematic research capability. The general uptrend has already come to an end. Strong differentiation and frequent fluctuations will be the norm for asset prices in the future. This requires investment institutions continuously go deep into the sub-asset areas of its concern for continuous tracking and research, truly focus on fundamentals, and fully grasp the industry development context. In the real estate industry, for example, high growth age has in the past, different regions, different category of the real estate segment on the asset price performance and cash flow income present a great differentiation, and this trend will continue. While maintaining close observation, we will continue to strengthen the tracking and research on core categories and segments that we are optimistic about;
(2) Ecosphere construction capacity. The ultimate return of distressed asset investment requires both continuous and reliable sources of deal acquisition and efficient disposal and exit, which are in essence the systematic construction of their own ecosystem. In the investment side and disposal side, we have a vast group of ecological partners to cooperate with for long-term win-win situation, which is the direction we have been striving for in recent years. By the end of the third quarter of this year, centering on DCL’s post-investment ecosystem, we have more than 1,300 partners of various types, and this “circle of friends” will continue to expand in the future. On the investment side, we have also established long-term mutual trust and cooperative relations with various types of institutions such as major commercial banks, asset management companies, trusts, brokerage firms and industrial parties, and have become mutually dependable counterparties and ecological partners;
(3) Operational improvement capability. Back to the basics, whether an investment institution can work on the underlying assets, improve its operational efficiency and return level, and restore a flawed asset to an average level or even slightly better than the average level, is particularly important under the new trend. Under this circumstance, the margin of safety held by the project has been improved under our active efforts, thereby helping to reduce the impact of cyclical fluctuations on the exit yield of our invested assets, which has been fully verified in a large number of cases in the restructuring operations of the projects.
The current market is undoubtedly a market where opportunities and challenges coexist. From DCL’s point of view, the main purpose of building the above-mentioned core capabilities is to allow us to judge, identify and ultimately seize the sub-categories that are still in the up cycle, so as to avoid falling into the vortex of some asset categories with falling prices. For example, when looking at the real estate sector, most of the distressed asset investors are still focused on the residential housing market, as well as high-end large commercial office complexes experiencing high vacancy rate and other issues, while some other asset categories relatively draw insufficient attention. As for the high-end serviced apartments, white-collar apartments, small single commercial offices, industrial logistics parks, etc. in core cities and regions that we are currently focusing on, the multiple indicators such as prosperity, rental returns, price stability and market demand are still relatively ideal, which also explains why our disposal efficiency still maintains the industry-leading level in the current environment. In essence, it is still a strategy of focusing on core assets, which has avoided many potential risks for us.
Furthermore, with the passage of time and the improvement of our cognition, the definition and boundaries of “core assets” are constantly changing. We believe that as long as the asset is in line with social and economic development, especially meets the basic rigid demand, has a certain degree of scarcity and uniqueness, at the same time, can generate stable and predictable cash flow, has the potential to become “core assets”. This scope, indeed, should not be limited to the real estate field. In addition to real estate, we also pay special attention to the shipping and logistics sector. Focusing on the special vessel assets that have been deployed, we have begun to gradually extend to other links in the industry chain, such as shipbuilding, docks, special warehousing, etc. We have also been paying close attention to the field of energy and minerals, and have done a lot of tracking and research. As a conventional category of overseas special opportunity investment, we believe that the opportunities in the domestic market are also gradually maturing, especially those related to new infrastructure and new energy transformation. In the future, we will gradually deploy on the basis of fully identifying the risks and potential profitability.
Looking into the future: leader’s advantage maintains, industry reshuffle intensifies, and the prospects are still bright
According to the official data released by the China Banking and Insurance Regulatory Commission, for two consecutive years in 2020 and 2021, the scale of non-performing assets disposed by the banking industry exceeded 3 trillion RMB, and kept running at a high level. In the context of uncertainty over the impact of the COVID-19 pandemic, increasingly fierce geopolitical conflict, and the macroeconomic transformation and upgrading, it is expected that the trillion-size distressed asset investment market will continue to expand, and high-quality investment opportunities will continue to emerge. We believe that, as has been evident in many other industries, the leading institutions in the investment field of distressed assets, relying on their own advantages, will still be the most promising ones to seize the golden period of rapid development of the industry and achieve rapid business growth.
In particular, from the perspective of the market-oriented investment institutions like DCL, the continuous reshuffle in the future may be inevitable. At present, the market has completed the evolution from the 1.0 era with simple arbitrage as the core logic to the 2.0 era with intensive cultivation and operation improvement as the core logic, which has put forward completely different requirements for investment institutions. On the one hand, if investment institutions can allocate relatively high-quality long-term fund commitments, and can scale appropriately, reduce leverage ratios to a more comfortable level, and treat distressed asset investment in a relatively long-term perspective, they will undoubtedly be more well-positioned and have stronger anti-risk ability under the environment of uncertainty. On the other hand, systematic and platform-based global management capabilities, superimposed on localized active management and ecosystem construction, can truly monitor the disposal and exit process of each asset, and grasp the initiative in own hands. This is the source of the industry’s future differentiation and reshuffle process. Only investment institutions that can better deal with the core points in the above two aspects at the same time can be expected to stand out in the future competition and avoid falling behind.
Looking ahead, distressed asset investment in the local market is still in the ascendant, with promising prospects. Although the traditional financial distressed market exhibits certain cyclical characteristics, opportunities will continue to exist. However, turn-around style distressed investment based on existing assets acquisition, restructuring, revitalization and integration has a broad prospect in many asset-heavy industries related to social basic needs and people’s daily life. This is what we need to grasp from the perspective of a long cycle.
From the perspective of short-term to medium-term trading opportunities, we need to be sufficiently vigilant and sharp. As mentioned repeatedly before, the market is currently facing many challenges, and our cognitive accumulation and construction will not be completed overnight. But at the same time, in the advantageous areas and asset categories that we focus on, once we find attractive investment opportunities, we must act decisively and with agility like hunters.
The above are some thoughts from the management team and myself regarding the market, the industry, and our expectations for the future on the occasion of the 7th anniversary of DCL, and all this also depends on your efforts and commitment. Thank you again for your trust and dedication to DCL, and look forward to continuing to work with you to create a better tomorrow!
Hualing Zheng
Oct 8, 2022