On my gravestone I hope they write that "He was a cloner" - Mohnish Pabrai
Below is a summary of talks that Mohnish Pabrai gave at ISB and MDI in Dec 2013. For those who are not familiar with him - Mohnish is a classic value investor in the tradition of Warren Buffett, Charlie Munger and Seth Klarman. He currently manages an approx $500 mn fund which is highly concentrated. And also has a bedroom in his office where he naps when he gets tired of reading or cloning.
Mohnish started Pabrai Funds in 1999 with $ 1mn which had his own $100,000. From 1999-2007 he compounded at 37% p.a. and 29% p.a. after fees. Before that from 1994-1999 $ 1mn compounded at 44% p.a (before fees). After 2007 compounded at -47.5% . Last 4 and half years compounding at 25.8% a year. He says he still has 11.5 years to go to compound at 26% a year. The reason he wants to compound at 26% p.a. is because that rate of compounding doubles equity in 3 yrs and turns a million dollars into a BILLION dollars in 30 years. He talks about that by narrating the parable of how the game of chess was invented to illustrate the power of compounding. Buffett was on the 18th square on the chess board when he first heard of him. He had compounded at 26% approx for the last 31 years.
Mohnish started Pabrai Funds in 1999 with $ 1mn which had his own $100,000. From 1999-2007 he compounded at 37% p.a. and 29% p.a. after fees. Before that from 1994-1999 $ 1mn compounded at 44% p.a (before fees). After 2007 compounded at -47.5% . Last 4 and half years compounding at 25.8% a year. He says he still has 11.5 years to go to compound at 26% a year. The reason he wants to compound at 26% p.a. is because that rate of compounding doubles equity in 3 yrs and turns a million dollars into a BILLION dollars in 30 years. He talks about that by narrating the parable of how the game of chess was invented to illustrate the power of compounding. Buffett was on the 18th square on the chess board when he first heard of him. He had compounded at 26% approx for the last 31 years.
Strategy
Charlie Munger once told him that a good investment operation can be built by focusing on
- Cannibalization (Buyback of shares)
- Cloning (Aping successful investors)
- Spin offs (De-mergers)
What stuck in his mind was the cloning part and he went about putting that in action with single minded focus. In Swami Vivekananda's words - Take a simple idea and take it seriously.
Cloning Warren Buffett's (WB) portfolio.
If an investor had just followed WB when he bought a stock and publicly disclosed it and bought it at the highest price that day, and sold it when he did and publicly disclosed it , that portfolio would have beaten the S&P by 11% say Gerald Martin (American University) and John Puthenpurackal (University of Nevada). Also contrary to popular belief, they found that Berkshire Hathaway invests primarily in large-cap growth rather than "value" stocks. Here is the link to the paper - Imitation is the Sincerest Form of Flattery: Warren Buffett and Berkshire Hathaway.
(Another interesting paper is on the way Buffett uses leverage - Buffett's Alpha).
How is WB's portfolio replicable ? if its so simple why does no one do it. He says that it took him a long time to come up with this insight. There is something strange in the human genome that makes humans very averse to being copy cats. most humans do not consider cloning as they think of it as beneath themselves. Microsoft (most of their revenues comes from windows and office which were cloned or bought) is not even a great cloner but they are big. Sam Walton was not a high IQ person. Walmart for the first 20 years did not come up with innovation. They just copied K-Mart and Sears. Burger King just opens up where McDonald's opens up. It has worked very well for them.
Fascinating insight on Auction Markets Vs Negotiated Markets
By nature auction driven markets which have faceless buyers and faceless sellers, are set up for distortion. If WB were to just invest in private cos he would have not been able to beat the market. Negotiated markets have a informed buyer and seller and deals happen over protracted negotiation. This results in lesser distortions.
(And this I think is what is happening in the Indian PE industry today. An Indian promoter knows very well that there is too much money chasing too few good deals even now after a number of PE funds have left or are going slow. Also perhaps explains that fact why a number of PE funds like Chrycap , Multiples, Sequoia, WestBridge to name a few are doing PIPE deals rather than private investments.)
Circle of Competence
Figure out the business and buy it at less than intrinsic value. 98% of the time you are not going to understand the business and it better to keep away from those businesses which you dont understand. Its ok to have a small circle of competence and still do very well as investing. Gave example of a developer and RE investor who invests only within 2 sq miles of San Francisco.
Buffett is a multi dimensional investor and does lots of other deals which are not just moat based deals. He also does a lot of arbitrage deals. So obviously, he does not blindly replicate what Buffett does, but he uses that as a high level filter and looks for opportunities which fall within his circle of competence. Also a number of opportunities like the GS and GE deals made during 2008 were exclusive to WB and would not be available to anyone else.
The Checklist
In the great crash of 2008, his portfolio got decimated and had a huge drawdown. Compounded at negative 47% almost a year and half - 2008 and 2009. He attributes this to hubris as he didn't have negative returns even in 2000 during the dotcom crash. He says that he completely missed the housing bubble.
He then drew upon the idea of a checklist from a NYT article and read The Checklist Manifesto by Dr Atul Gawande. Got the idea from the aviation industry where checklists were used to lower the number of human errors. He studied his own investing errors and asked the question as to were there factors which were clearly visible before the investment was made. In most cases where the investment went bad, he found that the factors were visible. He looked at his own portfolio as well the portfolio of investors like WB etc. and studied their mistakes and if these mistakes were identifiable at the time the investment was made. He then came up with his check list which has about 97 questions.
He then drew upon the idea of a checklist from a NYT article and read The Checklist Manifesto by Dr Atul Gawande. Got the idea from the aviation industry where checklists were used to lower the number of human errors. He studied his own investing errors and asked the question as to were there factors which were clearly visible before the investment was made. In most cases where the investment went bad, he found that the factors were visible. He looked at his own portfolio as well the portfolio of investors like WB etc. and studied their mistakes and if these mistakes were identifiable at the time the investment was made. He then came up with his check list which has about 97 questions.
Checklist focuses on
- Leverage: one of the mistakes in 2007 was buying a high quality mortgage lender but the co was highly leveraged. Do not buy a business which is dependent on the kindness of strangers.
- Debt covenants
- Moats
- Union and Labor relations
- Pre-investment talk with a peer fund manager (also got this from Munger)
- Management and Ownership
- How much stock do they own
- Do they act like owners
- Track record of promoters
He also had had a 21 month period where a number of investments went to zero. Post implementing this checklist his Max PERMANENT CAPITAL LOSS has been below 1% of investment - $ 5 mn.
He also does not go meeting management or kicking the tires approach. His view is that managements in US are much more transparent and honest than Indian management and have much longer operating history. So if he was focusing on Indian businesses, he would look at potential of becoming 10x-20x in the next 10 years. But even then if he was investing a large sum, then he would need to be more active and move to India. (post that though he has recently picked up a stake in South Indian Bank. )
Portfolio strategy since 2009
- 1st 75% of cash - 2-3 x in 2-3 years
- Next 10% - min 3x in 2-3 years
- Next 5% - min 4x in 2-3 years
- Next 5% - min 5x in 2-3 years
- Last 5% - more than 5 x in 2-3 years
Make lesser decisions. Take out sized bets. Also the last 10% usually stays in cash because of this portfolio construct strategy.
Become a shameless clone. Make a list of investors you admire and who have done well and make a list of their investments.
Portfolio construct
Munger feels 4 large stocks are enough. However, one can build portfolio from 10-12 large stocks. Don't focus on all industries and sectors. Buy full position at one go. No need to stagger. Too much diversification is a hedge for ignorance. In bad times (2008, 1929, 1987) the correlation goes to one and the diversification does not help.
Why do super investors invest alone and dont have a large team?
Even a 10 member team cannot evaluate more than a few hundred public companies every year. There are about 50,000 companies listed globally. The investment manager will end up taking shortcuts with or without a team as the data set is too large. Hence having a large team , where ultimately the decision is made by the fund manager is not different from a small team with the same fund manager. Other reasons could be differing circles of competence, large motors are not good at grinding away without result-less action. There is a natural bias for action. Also how do you compensate anyone who generate zero ideas. [Ask the MF and PE guys in India. :-) ]
Resources
Gurufocus.com, valueinvestors.com, sumzero.com, corner of berkshire and fairfax, the manual of ideas, edgar online, graham and doddsville (news letter of Columbia Business School), ibillionaire.com and dataroma.com & oid.com
However the single most quality is patience. John Templeton said that the best analyst will not be right more than 2 out of 3 times. No one can escape a loss.
Exit criteria
Write down your exit criteria before you enter. It should fit in 5-6 sentences. Basically price should be above intrinsic value. Evaluate intrinsic value every 3-6 months and not every day or week as businesses go through ups and downs. If a share you bought at $10 and you thought the intrinsic value is $40 at the time of entry. Say it goes to $ 40 in 2 years and you reevaluate that the business is now worth $ 60 then hold. If you think the intrinsic value is lower then you no longer hold and you sell.
There is another one which he gave at Columbia university. Will blog on that next week.
Link to the ISB talk:
Link to the ISB talk:
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