I attended Mohnish Pabrai’s annual meeting in Huntington Beach California last Saturday. I thought Mohnish did an awesome job as usual. I’ve been lucky enough to get to know Mohnish over the past few years and I grateful that he is so willing to share his ideas with others. Mohnish is both a friend and mentor. I admire his investing abilities and I also find him to be a very genuine person who like Buffett, is always having a good time and cracking jokes.
Here are my notes on the Pabrai Funds 2009 Annual Meeting in Huntington Beach California:
The formal presentation began with Mohnish discussing his checklist. He came up with the idea after reading an article in the New Yorker by Atul Gawande about checklists in medicine. He mentioned a few of the items on the checklist. Is the business simple to understand? Does the investment have a margin of Safety? Does the business have a moat? Mohnish went on to say that he has analyzed many of Buffett’s and other value investor’s mistakes as well as his own and added the mistakes to his checklist.
Mohnish cleaned house in the fourth quarter of last year. He sold many of the poor performers and weaker names and invested in natural resource companies and banks. He added 10 new positions in the 4th quarter of last year. The portfolio is now much stronger as a result. Mohnish's funds are up around 110% since the begining of the year.
He has also learned a lot from Seth Klarman about diversification. The old structure was geared towards 10 names with 10% of the fund allocated to each. Now, Mohnish has adopted a 3, 5 or 10 method whereby most positions will be 3 or 5% or the portfolio and if the seven moons line up he will allocate 10% to the investment. Mohnish said this should lead to better results.
Mohnish then discussed a few mistakes he has made. Compucredit is a subprime lender that was trading at 5x earnings and growing rapidly. The investment was sold at a 72% loss. The company has a win lose dynamic where is the company does well it is because they are preying on lower income customers.
Sears Holdings is another mistake. The funds lost 60% in Sears. Retailers are tough businesses. Mohnish is unhappy with himself for investing in this particularly because he wrote a chapter in his book Mosaic about why retailers are tough businesses. The thesis was that Lampert was very smart and would redeploy assets in better things. Sears also has below market leases and some very valuable brands. If it didn’t work out the real estate would be sold. But the problem is that 324,000 employees are between the investors and the assets. Sears cannot compete with Wal Mart.
An investment that worked out late last year was Level 3 bonds. Mohnish purchased the 3.5% 2012 convertible notes around November 4th for an average price of $432. The bonds have a $1,000 face value. He sold for $680. The bond markets were tremendously depressed during the crisis.
Q: One of the first questions came from someone who wasn’t happy with Mohnish’s performance last year. From peak to trough the funds were down 70%. This person said that was inexcusable. He also wanted to know why Mohnish doesn’t pay attention to the macro view? To avoid the huge losses last year Mohnish could have raised a large cash position?
A: Mohnish said that for the most part investors were blindsided. Also, he can’t go short and can’t take on leverage. Even if he focused on the macro view, it would have been very difficult to have forecasted what happened last year. He does have some appreciation for the macro view though. But, its much easier to focus on situations where the probabilities are easier to handicap. Mohnish will benefit from inflation because of the natural resource investments he has. Going forward the changes for the funds will be more diversification, a little more emphasis on the macro view and higher cash positions. He is currently a net seller of stocks.
Q: Due to the events last year do you still wait for 3 years for your investments to reach intrinsic value?
A: Mohnish said he is still patient with investments and will wait 3 years for a particular investment to reach intrinsic value. The majority of the gains in the portfolio are long term gains. He will try to minimize taxes. He would never place a stop loss order.
Q: Would you invest in Chinese companies?
A: He said most lay outside his circle of competence. But he has made investments for the partnership in India. He also has one Chinese investment. When making foreign investments he would focus on the ethos of management. There are many great companies but its hard to make investments from foreign companies while being based in the US.
Q: Would you invest in Gold?
A: No. Gold is too hard to value. It has luster value but the intrinsic value is unclear. He has investments in gold through some of the companies he owns. He wants to invest in productive commodities and then find the lowest cost producer. Then he would be interested.
Q: Would you invest in warrants, options or short stocks?
A: Won’t look at anything except possibly covered calls. He has experimented in his personal portfolio and so far only lost money. To invest he would have to go through an amendment process with investors.
Q: How does the Kelly criteria fit with the 3, 5, 10, portfolio allocation method?
A: Pabrai told Munger about his diversification ideas and Munger interrupted him and said that he is going in the opposite direction then him. Pabrai said that since he’s running other people’s money he has to be risk averse. Berkshire has had way more than 20 holdings for a long period of time and done very well. Some large bets have gone wrong. The Kelly Criteria works if the inputs are correct. In some instances he placed the wrong inputs in the formula. Some of his large bets went wrong. He did the formula wrong. He’s moving to a greater cash position like Klarman. When stocks are cheap such as earlier this year he puts the cash to work and now he is a net seller. So over time the cash position will build up as ideas become less plentiful and then cash will decrease when investment opportunities become more plentiful.
Q: Do you use the checklist for portfolio strategy? For example, is there an item on the list that says that you won’t invest a lot in just one industry?
A: The checklist is company specific. The portfolio structure comes before the checklist comes into play. He wouldn’t put a large portion of the partnership in one industry. There will always be at least one issue on the checklist for even a good idea. If you exclude leverage 80% of investments are ruled out. There is always at least one issue. 10 of the questions on the checklist are on leverage, 5 on management. Such as; does management have a large stake in the company? The checklist puts the tradeoffs in front of you. Another checklist item is; does the company have union issues?
Q: An entrepreneur asked Mohnish for some advice on running a business.
A: Focus on what you’re passionate about. Find what you’re interested in and good at. Then hopefully people you know well will give you money.
Q: Did Mohnish had any confidence issues in the 4th quarter of last year?
A: Mohnish said he had no confidence issues but he was watching redemptions closely. He saw the most incredible opportunities he’s ever seen. He was very excited about the investments that were being made. He said that he looked for investments in businesses that had moats and products that were essential.
Q: Why is Mohnish closing the fund to new investors at one billion in assets?
A: He wants to focus on smaller companies. If he had a billion dollars, with 5% allocation he would put $50 million into each investment. To stay under the 5% threshold he would need under a billion in capital.
Q: Someone asked if he could explain his Pinnacle Airlines mistake?
A: Based on value metrics it was very cheap. It totally fails the checklist. There is no win/win dynamic in the business ecosystem. Pinnacle would rake in money as the carriers lose a lot of money.
Q: Could you discuss the lunch with Warren and Charlie?
A: The lunch was worth every penny. 54 different topics were addressed. Buffett said that if he could have lunch with anyone it would be Isaac Newton and then he stopped and said no it would be Sophia Loren. Mohnish told Warren that Harina really enjoyed the lunch but her real love in life is Charlie. Buffett then arranged a meeting with Charlie. He found Charlie to be gracious, like having lunch with your grandfather. Mohnish asked Charlie how he handled his fund’s poor performance in 73 and 74. Most of it is family confidential. Warren told his kids that the most important decision they make is who they decide to marry.
Q: Any book recommendations?
A: The Black Swan was good but could have been written in only ten pages. Atul Gawande’s article in the New Yorker about checklists is a must read. That’s the article that sparked Mohnish’s idea to create his checklist. Also, Atul has written two books, Better and Complications. Mohnish highly recommends both. Mohnish also mentioned the book, The Miracle: The Epic Story of Asia's Quest for Wealth by business journalist Michael Schuman.
Q: Why were there so many redemptions?
A: Last year 15% of the fund’s assets left. Mohnish feels bad because these people were not able to let the investments play out and lost out on a lot of upside. The reason was partly hardship redemptions and fear of equities. Some investors went completely to cash. Some sold everything and went completely into cash. Investors like to do the opposite of what they should. They invest after stocks have done well and sell after they have done poorly. Mohnish received the most new money in 05-07) and the most was taken out just before the best gains in the history of the fund.
Q: Was he forced to change his methods and ideas or was it voluntary?
A: It wasn’t a change rather it was an evolution. Munger says to be a continuous learning machine. But, underlying principles always stand.
Link to Pabrai Funds 2009 Annual Meeting notes from Chicago