Complete Pabrai Funds Annual Meeting Notes: September 10th 2011 in Chicago

Note: A recorder wasn't used and therefore the following is a summary of what he said rather than an exact transcript.

Prepared Comments:

$100,000 invested in June of 2000 would be $554,600 today. This is an annualized return of 17.3% since 2000 vs. 1.1% over the same period for the S&P 500.

Assets under management: $580 million

A few past ideas:

International Coal Group:

Purchased in February 2010 at $4.3

Sold April 2011 at $10.30

138% return in slightly over 1 year

Wilber Ross founded the company and sought to replicate his International Coal Group playbook. Mohnish discussed Wilbur Ross's history and why it made sense to figure out what he was doing now.

· Mohnish liked that the company was going into metallurgical coal

· Fairfax was buying

He found the investment from looking at Fairfax fillings

Reverse engineering other people’s ideas is a very powerful approach

Terex:

Purchased in April 2009 at $12.21

Sold April 2011 at $37.3

206% return in 2 years

Mohnish became interested when the stock fell 90%

Thesis: 100+ NYC’s to be built over the next 100 years. Places such as China and India are expanding rapidly.

Healthy balance sheet to ride out the storm

2-3 years out sales and FCF are likely to grow significantly due to fast growth in the Asia markets

Downside protection: selling below replacement cost

Terex was a 2% basket bet

At a price of $16 Terex is interesting to look into again

London Mining:

Purchased at $1.26 in December 2008

Sold July 2011 at $6.3

360% return in two and a half years

Found this idea by looking at John Burbank’s portfolio. They owned over 13% of the company.

The company was trading for $146 million and had cash of $300 million

This idea plays into the 100 cities thesis

Low probability of loss of capital

Management was unknown

Took comfort in the fact that it was a net net and John Burbank’s ownership

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Some large caps are quite cheap today

The fund has a large non US exposure. 55-60% of the portfolio has revenue/ assets outside the United States.

25% of the fund’s cash went into recent volatility. The fund was able to put meaningful capital to work. The fund still has plenty of dry powder.

10% of the portfolio has gone into Japan. This is the cheapest market in the world. Very cheap and consistently profitable. There is a wide discount to intrinsic value and Mohnish expects good returns.

Mohnish’s first ever stock tip:

Taisei Oncho (JASDAQ: 1904)

Founded in 1941

Design and manufacture AC/ plumbing equipment

$59 million market cap

Cash plus bonds minus unearned revenue minus debt is $114 million

Net Income $6.1 million

Pabrai Funds has been buying every share offered since December 2010

Pabrai Funds now owns 1.4% of Taisei at an average price of $4.28

Consistently profitable since 2006

Tangible book value of $16.78

This company is trading at ¼ of intrinsic value

30-40 similar companies in Japan

Question and Answer session:

1. Can you discuss you investments in Goldman and BYD?

He doesn’t discuss particular investments. But he did say that he got the ideas from Buffett.

2. Given Buffett’s investments in Bank Of America, what does he think of the company? Are the warrants more attractive than the common?

He will not comment if he is buying or not. But he cited a study written by a few professors that said if you buy what Buffett has bought at the end of the month that his holdings are announced. And purchased at that week’s high price, you would still do significantly better than the S&P. So Bank of America is probably a good place for investors to look.

3. Mohnish invested in Frontline in 2004. The shipping industry is very distressed right now. Is it worth looking into at this point?

Very large crude carriers (VLCC’s) have a lead time of 3-4 years between when they are ordered and when they are delivered. A large amount of orders were placed at the end of the boom. Because of the long lead times and unintelligent behavior by ship buyers (namely the Greek’s) this market is subject to huge boom and bust cycles. The smaller ships and dry bulk ships have less volatility.

Frontline had most of its ships on spot charters. Then rates collapsed. Across the industry the single hull ships were taken out of service and scrapped.

If Frontline liquidated its VLCC’s, the value of those ships only fell from $70 to $60 million. The stock priced the ships at $15 million.

He bought because the stock was really cheap but it’s a bad industry over time.

4. Why were the investments in 2008 so small?

Some were basket bets on commodities and those were 2% positions. Normal positions are 5%. 10% is the most he will put into a company. The Japan basket bet is currently 10% and could reach up to 20% of the portfolio.

5. How do you value Potash?

He won’t discuss current holdings.

6. When making investments in commodity companies, how do you handicap for the risk of more supply entering the market and low barriers to entry?

It’s important to know where the company is on the cost curve. They want to own the lowest cost producer. When the price of the commodity goes down, the highest priced mines will close but the lowest cost producers will continue to be profitable.

7. If a 5% investment quadruples and goes to 20% of the fund, will you trim that position?

He’s never trimmed a position. The portfolio is less concentrated now, so this is less of an issue. He will only sell if it goes above intrinsic value or he finds a better investment. He usually sells at 90% of intrinsic value.

8. How do you analyze Japanese companies when information might be difficult to get or only in Japanese?

Financial statements are always in English and that’s the first step. It’s a basket bet so he spends less time researching each company than he would for a normal position. He didn’t hire a translator because that would take too long. Japan has a very trustworthy culture. He would never do the basket approach in China, India or most other places.

9. What are some investments that have lost money in the past?

The Pabrai Funds have made mistakes. The frequency of mistakes has gone down. One mistake was Sears. Many smart people were buying. Lampert is a smart guy. But he should have realized that it was a poor business. The business continues to deteriorate over time and the company has no moat. The funds lost 60% on their investment in Sears. He added an item to his checklist to prevent this mistake in the future.

10. Why did he sell Berkshire Hathaway?

Berkshire is doing well and is likely to do better than the index over time. But he can find cheaper things to invest in.

11. Are placeholders still part of the portfolio?

He no longer uses them because they didn’t work. One of his mistakes going into the financial crisis was being fully invested. The placeholders went down a lot which hurt the portfolio. It’s a much better idea to have a cash cushion because it tempers a decline and it provides dry gun powder when stocks get cheap.

12. Why is he invested in alternative energy?

He doesn’t want to discuss his ideas so he wouldn’t answer this question.

13. How do you structure the portfolio to withstand a crisis?

The portfolio has become more diversified and he also holds a larger cash cushion.

Charlie Munger says if you can’t handle a 50% drop in your portfolio then you shouldn’t be investing because that will eventually happen.

Berkshire Hathaway has gone down 50% a few times even though it’s a great business. In a stock market decline the fund will most likely go down.

However, investments such as the one in Japan will not be correlated to the rest of the portfolio.

14. How do you deal with currency in foreign investments?

He said he has no great insight into currency and he didn’t hedge the Yen. Since he started buying Japan, the index is down 15% and the Yen is up 8%. So far his basket is profitable. He ignores the effect of currency.

15. When investing in distressed businesses, how do you distinguish between a temporary verse long term problem?

He admitted making mistakes on this in the past. This is one of the most important factors and he spends a lot of time on this question. But it comes back to finding the intrinsic value and comparing that to the stock price. Investors need to determine if the distress is justified or not. For example, London Mining was worth much more in a private transaction than the price the Pabrai funds were buying at.

16. When you interview corporate management how do you evaluate their decision making process?

Most CEO’s are very poor capital allocators. A good way to judge management is to look at what tangible book value has done over time. He doesn’t interview management or even talk to them because he doesn’t want to be convinced by their sales skills. Management is always optimistic and this could cloud his decision making process. It’s better to evaluate management on your own and look at their past decisions.

17. For commodity based businesses you look at the cost curve to determine a good investment. What metric do you use for other industries?

In a commodity business he wants to own the lowest cost producer. It’s different for each industry. In retailing he looks at gross margins. This shows how well the company is run. In banking it’s the return on assets. It depends on the industry.

18. I didn’t quite catch the whole question but it had to do with his philosophy on following great investors?

This strategy doesn’t always work. But it’s a great search strategy. He’s found it to be very effective. Mohnish follows Klarman, Burbank, Watsa etc.

19. At what point does creating a basket distance you from understanding individual companies?

He’s borrowing the idea from Ben Graham. The situation in Japan is similar to what Graham was doing in the 1940’s and 1950’s in the US. This basket won’t dominate the portfolio, it’s a temporary thing.

20. How do you manage tough times?

People lose sight of basic reality. Most people freak out when their job is lost. It’s important to focus on what’s most important in life and what makes you happy. Keep a balance between work and those things.

Pabrai Investment Funds Annual Meeting Notes

I attended the Pabrai Investment Funds annual meeting in Chicago last Saturday. Mohnish did a great job answering questions, as usual. I've been lucky enough to get to know Mohnish over the past few years. Mohnish is one of the best fund managers in the country. He is one of the most genuine people I know and like Buffett he is always enjoying his job and cracking jokes.

Here are my notes from the 2010 Pabrai Investment Funds Annual Meeting in Chicago:

Prepared Comments:

The meeting started with an overview of how the fund has performed. Since the fund was started in 2001, it has returned 15.1% annually compared to -1.5% for the S&P 500.

$100,000 invested in the fund in June of 2000 would be $408,000 today.

Mohnish’s goal is to beat the index by 3% annually.

This past summer 3 interns worked part time on the checklist 2.0. They identified mistakes by great investors that resulted in a permanent loss of capital and analyzed why the mistakes occurred. They looked for commentary by the fund managers on these mistakes. They found that these investors almost never discussed their mistakes.

The biggest mistake was an investment in AIG by the Davis Fund which resulted in a $2 billion loss for the fund.

Mohnish said that the checklist is a great weapon in the Pabrai Funds arsenal.

Mohnish then went through one winner and one loser in the portfolio.

The worst investment during the period was Ternium which was actually sold at a small gain.

The winner he discussed was Teck cominco. This is the best investment the fund has ever made. The Pabrai Funds made an 8x return in only 3 months. Mohnish invested because they have some of the lowest cost mines in the world. The reason they were so cheap was because of a liquidity mismatch on the balance sheet. It had a large amount of debt coming due in a year. Mohnish felt that if they weren’t able to refinance the debt that they could sell assets piecemeal because of their highly diversified operations. In the worse case, the company would be worth a lot even in reorganizations because its book value was so high.


Question and Answer:

How Long did you follow Teck Cominco before buying?

Mohnish said he spent less than 5 days researching Teck because there were so many bargains at this time. Teck had a very solid moat because it was the lowest cost producer. To find Teck he looked at industry cost curves and paid attention to the lowest cost producers. The most important question to figure out was the liquidity mismatch.

Thoughts on Fairfax?

He doesn’t discuss current holdings.

Why don’t you discuss current holdings?

If investors get in the habit of discussing their investments they may end up suffering from commitment bias. If they constantly talk about how great a company is, they may suffer from a bias that could impair their judgment.

What are your views on position sizing?

His allocation policy changed in 2008 to reflect slightly elevated investment risks of his investment baskets and prior mistakes. If he has 10% positions it’s very hard to recover from a mistake. He discussed his new allocation framework with Charlie Munger who disagreed at first. After Mohnish explained it further, Charlie agreed that Berkshire Hathaway has achieved success with a more diversified portfolio. Mohnish talked about basket bets. When the risk is slightly elevated he will buy a basket of companies with small weightings. For example, he said he is currently researching companies in Japan. If he ends up buying companies there, he will buy a basket of companies each with small weightings in the portfolio. He said stocks there are very cheap.

What attracts you to a business?

When he finds a company that looks interesting he starts by thinking as a skeptic. He looks for something that will prove him wrong. He looks for areas of extreme mispricing. It has to be very undervalued but he also has to be able to understand it. He thinks there may be value in Coke bottlers in Japan. The Nikkei has done nothing for 27 years.

Has the increasing size of the fund negatively affect performance?

The performance of the fund has not been affected by size or fund inflows. He said that the fund is sitting on a lot of undervalue assets.

Has the economic turmoil changed your model?

Mohnish said he has more of an appreciation for macro issues than he has in the past. He also said that some macro trends make sense to base investments on. But the majority of macros trends such as inflation and interest rates are very difficult to predict and he doesn’t make judgments on those.

What are your thoughts on the financial industry?

Understanding management is key. You want to look for competent and honest managers. Because of the high leverage, management cannot make any mistakes in reserving. Also, it’s very difficult for outsiders to understand reserving. He couldn’t understand Citibank.

How much time do you spend on the balance sheet of companies you invest in?

Before he invested in Teck Cominco he read the last 8 years of annual reports. He spends a lot of time on the balance sheet.

What’s your philosophy on timing buying and selling?

He expects to be wrong in the future on selling. He said its fine to sell to early. If a stock goes down after he buys it that’s fine as long as he is still right about intrinsic value and he has dry powder to invest.

What did you identify with the checklist project?

The mistakes were concentrated in 08-09 and included a lot of financials. A lot of the mistakes were similar so he just picked a few. He analyzed Longleaf’s investment in GM. Longleaf’s management discussed the GM thesis in its reports. The mistake they made was they missed the forest from the trees. They missed the big picture. They figured that because GM did so well in the truck market that that would carry them through. They missed the fact that gas prices would rise to $3. He also said that he greatly respects these managers but that it’s important to learn from them. Longleaf also made the mistake of looking at the wrong variables.

How do you know where the edge of your circle of competence is?

If you have to ask yourself that question when looking at a company, then it’s probably beyond your circle of competence. You have to be honest with yourself. In the case of the Japanese companies he is researching, he has no interest in American listed Japanese companies. He will use the basket approach to Japanese companies because of the unfamiliarity. He also said that these Japanese companies are extremely cheap.

A business owner in the audience said after analyzing his own mistakes he noticed many of his mistakes were repeated. He asked if Mohnish had made a mistake more than once and was susceptible to reoccurring mistakes in one area?

Chris Davis wrote about a mistake he made in 2002. He ended up making the same mistake again in 2008 with AIG. Buffett made the same mistake twice as well with the original Berkshire Hathaway purchased and later on, with the Dexter Shoe purchase. Leverage is a very important factor to consider. One item on the check list is whether or not he suffers from any personal biases. The checklist forces him to take a step back.

Do you see any bubbles today?

Bubbles are hard to spot. Real estate in certain parts of China is probably a bubble. There are many bubbles around all the time. He mentioned a book called Trendwatching.

What’s your philosophy on investing in foreign markets?

He said that investing in US and Canadian companies that are driven by Chinese factors would be of interest to him. It’s important to understand foreign growth. You have to watch out for bubbles. China and India have good prospects but there may be an overall bubble. He’s very reluctant to invest in China but he’s interested in benefiting from Chinese growth. He skips Chinese companies because of accounting.

What does he think about natural gas companies?

The industry may be subject to a disruptive shift because of technological changes. The low prices may be permanent but he has no idea. The only good way to invest would be at the bottom of the cost curve and he can’t find one. There is no choke point in natural gas unlike iron ore. Natural gas also has substitutes. Mohnish recommended the book, Rational Optimist. He talked about how cheap energy allows countries to create more fresh water which will allow more agriculture.

How do you prevent macro issues from blinding investments?

He’s learned to appreciate macro issues more than in the past. As an investor you can’t get a handle on all factors. So it makes sense to spread ideas out more. The micro factors trump the macro factors. The company has to be able to control its destiny. He looks for staying power so the company can withstand shocks.

This question came from an investor who has to pull out money for living expenses. He asked how he can get more visibility on what taxes will be?

Mohnish practices tax planning in the funds. He sells holdings between the funds to cancel capital gains. The statements sent to shareholders should give them a good idea what the expected tax rate will be. Mohnish is a big tax payer so he is very sensitive to tax issues.

Is your philosophy on portfolio allocation shifting more towards preserving wealth instead of growing it?

The Kelly Formula is only correct when making many bets. He always under bet the Kelly Formula. Since Mohnish is making few bets, the Kelly Formula doesn’t work. He never fully used the Kelly Formula because it would have told him to bet more heavily. Return of capital is more important than return on capital. If people redeem their money during down times that is permanently lost capital for those people.

Can you name some great companies that you’d love to own at the right price?

Ikea, In and Out Burger, Costco, the low cost mines owned by BHP and Rio Tinto. Great companies are all over the place across the world. There are great companies in India and China but and ownership issues exists over there. Pricing is also an issue. Ben Graham’s approach was to go to the store and buy what was on sale and Charlie Munger’s approach is to go to the store and wait for quality items to go on sale. He likes Charlie’s framework.

What extra work do you do to analyze financials?

He’s reluctant to own most financials. They do own Goldman Sachs. He’s read two books on Goldman. It’s a great business. He doesn’t have a problem with management ethos but it’s improving. It’s a very complex business. They have the potential to grow huge overseas because they have few offices overseas right now. Since it has opaque parts to its business he made it a basket bet.

Does checklist address good portfolio strategies?

No. The checklist deals with analyzing companies. Mohnish recommended that this person read the fundamental value investing books. Mohnish always tries to learn from others.

Would you be more interested in a more certain intrinsic value or a cheaper price?

Currently the fund holds a lot of cash as there is less cash in the fund he demands higher discounts for new investments. I wasn’t able to too write down most of his answer.

What’s your average cash level since 1999?

In a crisis, cash plus courage is priceless. Next times a crisis strikes, he wants more cash. Instead of jumping from his second best to his best idea he instead lets investments play out and clings to ideas instead of jumping around.

How does Mohnish spend his free time?

He does plenty of other things. He has a daily nap, plays racquetball and plays bridge.

Sold Horsehead Holdings

I purchased shares in Horsehead Holdings back in March at $4.23 per share and I recently sold my investment at $11. I made at 160% return on my money in 6 months. I invested in Horsehead because it was trading for $150 million with $123 million in cash and a net current asset value of $150 million. I was buying at 40% of book value and the replacement value of the facilities is over one billion dollars. Not only was Horsehead incredibly cheap but it was a great company to. It’s the lowest cost producer of zinc in the world and the only company that can use 100% recycled feedstocks in its facilities. Horsehead’s competitive advantage in the zinc market is further benefited because its facilities are next to steal mini mills with long term contracts for the delivery of feedstocks. It would be extremely hard for a competitor to come in and hurt the company’s supply of low cost EAF dust. No other company has been able to develop recycling techniques comparable to those of Horsehead. Horsehead has a large moat in the zinc market. I also recognized the potential for higher economical uses of the iron by product that could be worth up to $13 million per year. In addition, the company continues to increase the percentage of feedstocks derived from EAF dust. 66% of the company’s feedtsocks are EAF dust and for every percent increase, margins expand.


Revenue decreased 64% in the first half of 09 because of lower realized prices for zinc and a decrease in shipments. Net income was negative $24 million vs. a profit of $24 million in the same period last year. The decrease was due to lower prices of zinc and less production. The company idled some capacity but fixed costs are still high. EAF dust fees were also substantially lower. A $22 million charge occurred due to hedging activities.

The company resumed operations at its Rockwood, Tenn., recycling facility in August. The company said it expects to restart one of two kilns at the Rockwood plant in mid-September. It had idled the facility as a result of the economic downturn.

In September Horsehead issued 9.1 million shares in a secondary offering at $10.50 per share less discounts and commissions of $0.525 per share and received $80 million in cash. “The Company intends to use the net proceeds from the offering for general corporate purposes, which may include capital expenditures, acquisitions, working capital, investments and the repayment of indebtedness.” After the offering there are 44.364 million diluted shares outstanding. Horsehead currently has $160 million in cash when the proceeds are factored in and a market capitalization of $500 million.


The secondary offering changes the dynamics for my investment in Horsehead. The market cap of the company is now around $500 million. The price of zinc has averaged about 90% of the cost of production. Unlike oil or many other commodities, zinc is so plentiful in the world that the price of zinc is based on the cost of production and has averaged around 90% of production. Predicting the price of zinc is impossible but looking at historical prices and the cost to produce zinc it doesn’t look like their will be any large upside from here. I have no competency in zinc prices and the price of zinc meant little to my investment in Horsehead. I invested because it was the lowest cost producer of zinc and it was trading below net current asset value. Horsehaed is no longer cheap and based on historical earnings it appears fairly valued.

Alex Bossert Featured in "Of Permanent Value: The Story Of Warren Buffett" By Andy Kilpatrick

Last year I was lucky enough to be featured in a chapter of the 2009 edition of Andy Kilpatrick’s book “Of Permanent Value: The Story of Warren Buffett.” I was in chapter 205, page 1169-70. The chapter was titled “The Story Of Alex Bossert, Age 17.” Andy Kilpatrick is good friends with Warren Buffett and has been updating the book every year. The book is sold directly at the annual meeting every year.

Next year’s edition will be out in April and has a chapter on me and my friend Eric Schleien. Chapter 215 is titled: “The Alex Bossert Story, Age 18.” The chapter is on page 1215.

“Of Permanent Value” is considered by many to be the most extensive book about Warren Buffett and value investing.

View Andy Kilpatrick's web site

Purchase his book on Amazon

Read the chapter that will appear in the 2010 edition of the book

Pabrai Funds Annual Meeting Notes 2009: Huntington Beach California

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:

Presentation:

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.

Questions:

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

Mohnish Pabrai Interview

Mohnish Pabrai started the Pabrai funds in 1999 and has since had returns of 25% a year on average net to investors. I have been following Pabrai since I read an article about him in Forbes Magazine in 2004. I recommend the article , in it Pabrai talks about his investment in Frontline. In the interview published today by Smart Money Pabrai talks about one of my largest holdings Pinnacle Airlines.

Smart Money: What stocks do you like now?

Mohnish Pabrai: Pinnacle Airlines. Depending on
how
things work out, it's anywhere from a double to five or six times return in
the next two or three years.

SM: An airline?

MP: It's a regional jet
company. The large airlines,
like Northwest and Delta, outsource the small planes to Pinnacle. Many of the
reasons why airlines are so terrible — load factors, price wars — don't
matter.
The revenue is the same whether there is one passenger or the plane
is full and
whether Northwest charges $200 or $2,000 round-trip. The
contracts are
long-term, usually 10 years, and will hold up in the event of
a merger. So you
can estimate what their cash flows will be many years into
the future.

SM:
What's the investment case?

MP: Pinnacle has more than $10 a share in cash
on the
balance sheet. In the next few years, free cash flow will be $3 to $6 a
share, depending on how much more business they get. With a simple 10 or 15
multiple on those numbers, you end up with $30.

SM: Why are the shares so
cheap?

MP: One overhang is that they have a past-due contract with
pilots.
But not a lot of Wall Street analysts follow Pinnacle, and the
business itself
is changing. The evolution away from hub-and-spoke and
toward more nonstop
flights is driving demand for their services. When you
connect one small city to
another directly, you aren't going to run a jumbo
or a 737.

Full Interview Via Smart Money

I also highly recommend Pabrai's book The Dhandho Investor: The Low - Risk Value Method to High Returns.