The most important event of the first quarter for our team was the Chinese New Year Spring Festival. The year of the Rooster symbolizes fidelity and punctuality, with its early morning crowing perceived as a call to action – urging us to roll up our sleeves and get to work. The holiday also rings in the busy season for us, with new deals commencing in earnest, annual budgeting finalized, and strategic planning meetings.

Macro discussions at this time last year centered on debt in the system, fiscal stimulus, and money flowing offshore. This year the focus remains on debt, asset price inflation, retail sales gains, and the stabilization of the RMB as capital outflows slow. Debt as ever remains the X-factor that weighs on valuations, perceptions and the risk premium many associate with China. The observers we trust the most believe this is not a systemic concern, but for every two in that camp, there is a Cassandra with the opposing view. What all should agree on is that the effects of last year’s stimulus measures are indisputably material. Retail sales running at double-digit gains continue to mirror the underlying trends we see in our portfolio companies, and in the pipeline businesses we are targeting. Chinese New Year sales reached RMB 840bn, up 11.4% year-over-year, with tourism up similarly to 100bn from 90bn last year. Overall, China’s long-term growth trajectory remains on track, namely:
(i) transitioning China from an export and investment-led growth model to one empowered by the domestic consumer, (ii) promoting global trade and commerce through initiatives such as One Belt One Road, and (iii) further liberalization of the capital markets. The recent announcement that the US will soon restart beef imports to China, which were initially halted in 2003, will provide an attractive alternative for Castle Snack’s to source more competitive pricing for raw beef for its beef jerky.

Capital controls have limited our ability to distribute investment gains, but money staying onshore has created demand for investment, including a surge in the number of domestic IPOs. Bloomberg reported that outbound takeovers by Chinese companies buying offshore assets are down 67% this year due to capital controls, the biggest drop since the financial crisis. Regulators continue to place obstacles in the way for getting funds offshore, which has helped the RMB stabilize to a far greater degree than anticipated. It has also made for very high breakup fees, something, to reassure, we very much have in place with exits we are working on.

Our industry is evolving as well. There is a notable uptick in demand for private equity from domestic entrepreneurs and founder/managers, which we believe will continue to serve China’s capital markets and our strategy well. Venture still attracts the most mindshare, and probably the most capital as well. However, in the more mature private equity strategies, we believe control continues to stand out as offering the best risk-reward, and we remain an early mover. Skillset and focus is winning out versus the pure capital, relationship-driven approach, and younger team members and management are at a distinct advantage as opportunities and structures evolve very quickly, especially onshore.

We are seeing a few key reoccurring themes and trends which continue to drive our investment strategy. Firstly, we remain focused on building scale through platforms and believe that rollup strategies work. Secondly, we will keep fighting for control. The more control we have, the better the outcome will be and the easier we find it to make improvements and scale our businesses. Thirdly, move quickly. China is the world’s most dynamic economy, and everything moves faster. Changing management, rationalizing product lines, or implementing change is better done fast and swift. Lastly, be mindful of leaving cash on the table. We were early to exit an investment we held in Hangzhou Kings at well above cost due to concerns over our status as a foreign shareholder. We chose to exit rather than propose creative structures to our LPs that could, perhaps, have retained our involvement despite layering on structuring risk. Hangzhou Kings went public domestically this quarter, and after trading at near its limit nearly every day since, the current valuation of the company would have implied more than 12x our invested cost. As we plan for future exits, we will work to educate our investing partners on where we may be able to take prudent risk to capture upside in situations where often structures require more work to understand.

That leads to the greatest challenges we face in our portfolio: modernizing thinking, continuing to execute, and accelerating the pace of all that we do. China today is about the new taking over from the old, modern outpacing traditional, China’s youth consuming much differently than their parents, and young managers moving faster and more creatively than their 45-year-old-plus peers. We believe that our ability to quickly modernize, whether in Castle Snack’s manufacturing operations, Yao Taitai’s products and packaging, or Yeehoo’s distribution, is truly where we can move the needle for our partners.

This Chinese New Year, we celebrate the 15th anniversary of China’s accession to the World Trade Organization. GDP per capita now exceeds US$8,500, up from US$1,200 in 2001, and the World Bank classifies China as a middle-high income society. Morgan Stanley believes China will achieve high-income status by 2027, yet China only ranks as the 75th richest nation per capita on earth. There is still a long way to go.

Highlights from our businesses
The strength of the Chinese consumer delivered for our companies this year, dwarfing any drag from the more sluggish aspects of the broader economy. Our businesses continued to grow revenue, with profits rising and the following notable accomplishments:

– Yeehoo ranked as China’s top babywear brand, tripled its November 11 Single’s Day e-commerce revenue, and attracted numerous suitors
– Castle Snacks completed two further acquisitions and reached domestic-IPO scale
– Lao Heng He quadrupled e-commerce sales growth, and doubled its traditional channel sales, two of our most important KPIs

Exits and distributions
We had success translating momentum into exits and generated distributions from several of our businesses during the year, which in total should return limited partners a substantial amount of capital. In most cases, comparable valuations for our businesses rose considerably, which will drive further uplifts in valuation. While we generally do not underwrite based on multiple arbitrage, we believe it presents us with tremendous optionality for additional upside.

Capital committed to new investments
We committed more than $100 million to new investments during the year. We were most aggressive in buying snack food companies, with the acquisition of Yao TaiTai, Orchard Farmer, and LifeFun. We also closed our investment in Honworld.

While this represents a growing amount of investment for us, it is still small compared to the size of the opportunity we are addressing. Far too small in fact. In critiquing our own performance, we believe that we have left too many opportunities sitting on the table, where we could have leveraged our platforms and driven growth at reasonable valuations. In babywear, for example, there were several large acquisitions we should have made, where investment and execution risk could have been mitigated by leveraging our market leadership. We missed similar opportunities in snack foods. We will work to better present these investments to our investing partners in the future, and ensure that we do not miss chances like these again.

Pipeline and investment focus
You will hear more from us about baby- and kids-related businesses, snack foods and condiments. Our team has strong conviction that our foothold in these sectors is an enormous opportunity to put more capital to work and deliver investment gains. We have about a half-dozen new platform concepts under serious consideration in areas like early education. We believe that we can leverage the large base of VIP customers we have built up through our Little Star Brands platform and provide Chinese families with more professionally run, higher quality educational services to compliment the clothing and supplies that our brands provide. We look forward to discussing similar ideas in travel, cosmetics, and other sectors with you soon.

Risk factors
We begin the year with more of the same concerns over a potential credit bubble, the weakening RMB, and the increasing the risk of some form of trade war. Domestic politics will also be a factor as the quinquennial process of making leadership appointments, including Xi Jinping’s likely successor, will occur.

Goldman recently postulated that a hard landing is likely over the coming three years. Morgan Stanley takes a different and very bullish view on China, believing that a shock will be avoided and a focus on domestic consumption and services will lead to high-income status by 2027. So, Goldman fears a crisis, Morgan Stanley urges focus on the long term positives, and, at Davos last year, George Soros said he was no longer expecting a hard landing, but already “observing it”! From what we see in our businesses, we believe that a series of soft landings occurred in 2008-09, 2012-13, and 2016. Together, these may be the speedbumps that slow growth, lower valuations, accelerate restructuring, and prevent the economy going off the rails. For now, we concur with Morgan Stanley (“[they are] able to navigate [it]”).

As for our investment strategy, we believe that for so long as China remains underdeveloped, with a high savings rate, reasonable asset prices, and a growing middle class of aspirational consumers, the opportunity to buy good consumer-focused businesses with the potential for growth at reasonable prices is compelling. We remain convinced that putting capital to work and mitigating risk through our operational efforts, disciplined focus, and ability to leverage control is a wiser course of action versus remaining underinvested.

Potential surprises
Readers of our year-end letter (and of Nostradamus’ works) want predictions. Below is a recap of how our forecasts from last year fared, and the trends we believe remain in place based on the feedback we receive from our businesses, management teams and dealmakers:

Last year we forecasted that the impact of one-child reform would kick in. And it has. CLSA recently reported that China’s birth rate recovered to 12.95% in 2016, the highest since 2001. Expect the birth rate recovery to continue near term with 18-20 million new-borns in 2017-2020 – a “mini baby boom” that will drive consumption. We also predicted liberalization of the Hukou System would fuel further urbanization and internal migration, which was premature but remains low-hanging fruit to drive future consumption, and we believe it will occur soon.

We believed that the upper middle class would surprise and deliver non-linear growth rates of premium consumption in areas such as healthy food, overseas travel, education, healthcare and higher quality apparel. This trend continues. Each of China’s online shoppers will spend US $473 on foreign goods this year, up from $446 in 2015. Luxury brands like LVMH, are reporting “better momentum after a tough 2015” as are Re?my Cointreau and Kweichow Moutai. “Re-shoring” of luxury is accelerating as China cuts duties on luxury goods imported through official channels, and cracks down on “daigou” (overseas personal shoppers unofficially bringing back grey-market goods). This dovetails with our channel checks that show better sales domestically, but weakness in places that cater to daigou, like Hong Kong.

We were correct in foreseeing that the weaker RMB and lower equity valuations would fuel M&A. The demand to acquire good companies we control is positively impacting our portfolio, although the weaker currency has led to outflows for China-focused fund managers, and macroeconomic concerns for investors globally. We expect the currency will continue to experience a managed decline, and that it is the volatility, not the absolute level, of the RMB that most concerns policy makers. The market will grudgingly conclude that China has the growth, reserves, policy tools and force of will to bring the RMB in line with fundamentals while avoiding overshooting to the downside.

We also called the narrowing of the valuation gap between domestically listed A-Shares and Hong Kong-listed H-Shares, especially in the consumer sector, although our belief that this would be fueled by a rebound in the valuations of H-Share consumer stocks, which traded sideways, was a bit off. For the coming year, we anticipate that the stock-connect, which provides domestic Chinese investors access to reasonably-valued Hong Kong listed companies and, indirectly, foreign currency exposure, will become too tempting to resist and offer reasonably priced yield, versus the very expensive growth on offer elsewhere.

We overstated the risk that businesses and startups in China “losing more to sell more” would rattle investor confidence. Enough unicorns were minted to prove us wrong. Going into the New Year, we still see an overabundance of capital searching for a home, especially in early-stage venture-land. Growth is overvalued, but expect nonsensical start-up valuations and the general dodginess in industries like peer-to-peer lending to persist for a while longer. Domestic equity valuations will also remain high. While the local markets are imperfect, the trend toward higher quality listings, better regulations, greater institutional participation and more overseas involvement combined with China’s extremely high domestic savings rate will keep valuations robust.

Priorities
Finally, we would like to recap our priorities for 2017:

First, we will continue making distributions and complete further closings for the exits we commenced in 2016. We believe we can do this while ensuring that these companies continue to grow.

Second, we aim to sell down our last two remaining investments in LCP-II, our vintage 2008 fund. To this end, we are off to a good start in 2017.

Third, we will optimize our remaining investments in LCP-III to achieve higher valuations, generate distributions and achieve industry-leading returns.

Fourth, we are taking advantage of the platforms we currently own to invest more capital, with a target of exceeding the $100 million we committed last year into further snack foods, sauces and baby/kids-related businesses and one new platform.

Fifth, we continue to build Lunar’s franchise and reputation.

随着城市化的发展以及人均消费水平的不断增长，正在崛起的中产阶级将对中国未来的经济产生深远的影响。根据麦肯锡的调查报告，中国15-59岁的工作人群预计将在未来的15年中增加1亿人左右，同时带动本土消费从2.5万亿提升至6.7万亿。这些消费者对自己未来收入增长非常乐观，并越来越追求高质量的生活方式。

这样的趋势对于中国消费行业的未来意义重大。我们也看到婴童服装行业由中国“第三次婴儿潮回声期”以及计划生育新政带来的积极影响。年轻夫妇们越来越多地开始二胎计划，每年新增的新生婴儿预计将达到150万到400万左右。更多新生婴儿以及更加富有的父母对我们旗下的英氏，皮卡泡泡，I Pinco Pallino等品牌意味着更大的销售潜力。

中国未来新生儿的潜在需求吸引了许多国外品牌，例如在服装、玩具、书刊及教育等各方面都有所建树的迪士尼。同时，本土品牌也在加紧加强自己的产品及品牌建设，以巩固并拓展在婴童市场内的地位。婴童市场也吸引了资本市场的目光 – 从网上母婴产品零售商到儿童动画电影制作商都得到了资本的青睐。

婴童服装是婴童消费产业的中心，与玩具，尿布，食品一起占据了近50%的婴童消费市场。根据中国儿童产业研究中心的预测，婴童消费产业未来将获得15%的年复合增长率，其中婴童服装市场规模将从2013年的1160亿人民币增长到2018年的2000亿人民币。

为了吸引更多消费者并把握住大趋势带来的商机，婴童品牌必须致力于改进产品设计、质量和安全问题，因为中国消费者对于产品功能，品牌形象和安全比对于价格更为敏感，愿意支付更高的价格以获得更加安全可靠的产品。另外，企业也必须完善线上线下的分销渠道，让家长们更为方便地为自己的孩子们购买产品。对于英氏和I Pinco Pallino这样拥有高质量产品和强大分销渠道的品牌，中国新一轮的婴儿潮将为它们带来可非常可观的可持续发展机会。

美国50后、60后群体的成长历程带动了美国跨世纪的产业变革; 而在中国，90后对消费的影响正在伴随其成长轨迹而递增：他们正在拥有越来越多的可支配收入、越来越高的生活标准以及对未来的期望。

以前，社会经济和政治不稳定因素酝酿了中国超高的储蓄率。今日，这些影响因素逐渐淡化，人们的消费习惯在重塑。90后一代人在独生子女的光环下长大，享受着更高的生活标准，以及父母随手就给的零花钱。这一代人随后进入了职场，并开始分配他们自己越来越高的收入。他们极度依赖网上消费和国外产品消费，表现出对潮品、奢侈品、新产品的极高消费欲望。随着90后开始成为父母，我们预期他们的习惯仍然会侧重于消费，而不是储蓄，这对我们的婴童服装平台-小星辰以及高端休闲食品平台- Castle Snack的销售增长非常有利。

中国90后的消费模式可总结为6个方面: 1）娱乐和社交， 2)好故事和能引起共鸣的产品及品牌， 3) 受日本御宅文化影响的消费4）与众不同的消费体验，5）信用卡主导的超前消费， 6）通过手机等移动平台的消费。根据北京大学和网易的联合研究，90后首选的消费是服饰，鞋和首饰，并且他们愿意为计划外的旅行、高端首饰和装饰品买单；他们的消费决定更容易受商业领袖、学者和名人的影响。

在云月旗下品牌根据消费者的喜好本土化以及开拓销售渠道的过程中，中国消费人群的偏好变化扮演了重要角色。在云月的生态圈里，英氏和姚太太在电子商务方面的成功证明了我们对于市场动态的合理把握。

我们相信未来十年将是个人主义崛起的时代，生活习惯会由节约型转化成消费型，政府政策将支持以消费为主导的经济增长。应对这些变化是我们现有业务以及我们收购和投资目标面临的一大挑战。

近期各行各业增长放缓，并且信用担保难度增大，使得以不同方法管理消费业务成为必要。单一依靠宏观经济发展而增长的业务将面临种种挑战, 不再能水涨船高。我们正进入一个新的发展阶段，稳健的管理流程需体现在各个层面。整体收入增长已不能再简单地靠折扣优惠带动，而是必须与业务分销网络的加强和产品供应的提升相配合。同时，我们也必须利用更积极的供应链管理和强大的人力资本，提高业务效率。

企业创办者们投入了大量精力和才能使企业发展至今，但现在，他们必须引入具备应对变化所需能力的专业管理人员。很多企业已开始并在继续建立强大的专业管理团队以协助企业发展。而其它企业，我们预期他们会向云月这样的企业寻求解决方案，由我们引进新的管理人才，精简决策流程，和正面临接班人或其它问题的股东们建立双赢的合作伙伴关系。我们相信，作为投资者，肩负着协助企业面对各种难题、帮助企业创造新一轮增长机遇的使命，我们的表现会更加出色。

我们相信流程化管理是为旗下企业创造价值的最佳手段。我们应用在英氏婴儿服装业务的大多数流程可直接应用于皮卡泡泡，而且也适用于管理永红或扩大智强的产品线。不管是婴儿服装或饮品，我们所面对的有关产品开发、分销、营销、供应链管理、物流或人力资源等方面的问题是非常相似的。

与此同时，我们也相信流程化为我们提供必要的透明度以作出明智决策并创造价值，使我们成为合作伙伴的最佳受托人。这正是云月投资的核心价值。我们明白，作为资本管理人，我们必须非常重视我们的责任。

至此，我们欣然为您呈现2014年度至今的进展：

• 我们已全部或部分退出超过75%的已投项目，退出方式包括股权转让(55%)、IPO(30%)和资本重组或其它利润分配(15%)。我们认为，均衡多样的退出方式是标志性、差异化的投资策略的体现，同时也展现了我们业务的适应能力和专业团队的智谋。
• 尽管中国的IPO市场正面临巨大的挑战，但我们目前管理的两支基金LCP-II与LCP-III在中国的表现都处于同行中领先的位置。
• 我们开始着手两个处于投资流程晚期项目的退出，目前已实现了部分退出。其中一个项目是万洲国际──中国最大的猪肉生产商，另一个是云南林业──我们的林业和木材相关品业务投资。
• 另外有两个项目通过引入少数股权投资者也实现了部分退出，我们相信这样的做法可为业务带来重大的战略性意义。其中一个是把小星辰品牌集团少数股权出售给中国最大百货公司拥有人之一，另一个是将I Pinco Pallino少数股权出售给国际知名影星章子怡。
• 我们将上述四个项目部分退出得到的收益全部分配给我们的投资人，兑现我们及时回报的承诺。相比强调未实现的价值，我们更青睐于早期给投资人分红。
• 在所有情况下，我们认为深度参与是业务成功的主要动力。在我们的投资组合中，控制度相对较高的投资普遍表现较好，而且也有较多低风险的退出选择。我们坚信，运营增值是推动投资业绩的最好方法。

在过去半年里一直有中国经济增长速度放缓的报导，但我们认为这预示着中国经济正朝着更健康、更稳定的方向发展。不论经济增长率是处于高位的8-10%还是稳定的6-7%，一个重要的现象是，国内消费随着中国消费者的崛起而显著提升。政府相关政策也侧面反映除国家对促进国内消费的支持──变革正在进行中。在中国消费蓬勃增长的趋势下，我们相信，随着资本市场的不断开放和IPO市场的再度活跃，我们的投资战略──投资定位良好的消费企业并帮助他们改善运营增加企业价值，将会取得很大的成功。

扩大中产阶级的规模，提高其生活水平是今年两会（一年一度的全国人民代表大会和中国人民政治协商会议）的主要政策目标。中国坚信，城镇化、增加可支配收入、扩大社会保障覆盖范围是实现这一目标的方案。这些新政策鼓励我们去为数量更多、更富有和更敏锐的中国消费群体提供产品和服务，但同时也给我们带来了相应的挑战。我们将在本月的评论中详细讨论这些挑战。

城镇化

中国超过半数的人口居住于城镇。城镇人口占比从10年之前的44%增加到了现在的52%。中国政府的目标是在未来7年之内将1亿乡村居民搬迁到城市，使城镇人口占比达到60%。为了在2020年之前实现这个目标, 政府已经批准了一个约40万亿元的发展计划，这将促进基础设施建设、鼓励商业投资、创造更多工作机会，并促进区域经济的发展。但即使实现了这一目标，中国的城镇化水平要赶上韩国、美国和台湾仍然还有很长的路要走。这些国家和地区的城镇人口占比都已经高于75%。从长远来看，城镇化将带来巨大的目标市场，但是在短期，它可能会加剧消费偏好和支付能力的区域性差异。客户细分将成为云月投资运营过程中面临的一大挑战，对此我们需要做出各种思考。例如，我们努力推动经营管理人员提供定制化服务和定位更清晰的细分市场和价位来应对城镇化方向对我们童装业务的影响。

可支配收入

政府的另一目标是到2020年将居民可支配收入提高一倍，即从21,986元提高到43,792元。为实现此目标，政府将采取一系列措施，其中一个措施就是重新划定最低工资水平。这将导致在这一个十年后，中国居民的工资收入增长32%。尽管工资上涨将会给劳动密集型产业带来压力，政府希望借助这个措施促进劳动力向三、四线城市流动，从而促进当地经济的发展，提高当地居民的收入水平。目前中国各主要地区的工资水平和新工资政策的预计影响如下：

我们投资战略的指导理念是关注附加值更高和品牌更优的公司，我们相信这样的公司更能吸引消费者。因此，与过去三年中受投资者青睐的新兴快餐店这种劳动密集型服务相比，我们仍然将重点放在像英氏、智强、牛头等高价值的品牌上。另外，我们非常专注于通过运营增加企业的价值。经营需要重新分配劳动力、应对快速上涨的工资成本，同时还需要生产更高质量的产品的公司，比起简单的资金投入，即典型的中国私募股权投资，需要更多的经营附加值，即人力投入。我们需要更加明智的经营管理者，需要一个帮助他们提高工作质量的过程。

扩大社会保障覆盖范围

中国的财政状况虽然仍旧良好，但是政府将通过提高债务为二次收入再分配计划提供资金。相比去年的财政盈余近1万亿元的情况，今年债务占国内生产总值比率将上升至2%。该计划旨在扩大医疗保险和社会保障的覆盖范围，希望缩小城乡储蓄率的差距。目标是增加居民的安全感，促使更多资金流向消费和风险投资。我们相信缺乏安全感是造成中国高储蓄率的原因，它还催生了对关注健康、安全和优质产品的需求。满足这些需求仍然是很大的挑战，也是巨大的机遇。

再平衡和成功机会的早期迹象

刚闭幕不久的两会引起了人们对城镇化的空前关注。实际上，这种势头早已存在。例如，在我们大部分公司所在的省市——云南、贵阳和四川——城镇化增长率已经稳超那些同级别的一线城市。尽管人们普遍都在担心市场需求增长放缓，但销售数据显示消费者对高质量产品的购买力仍然很强。但由于市场的高度分散，一些靠当地特色风味吸引全国消费者的零食企业本身却面临着扩张的障碍。最突出的例子就是肯德基。它是中国最令人仰慕的快餐连锁企业，但是却在不同的地区（如北京、上海和成都）提供不同的菜单。这些复杂性造成了进入市场和管理方面的困难，同时也为那些提供经营专长和人力资产的公司创造了机会。