On May 11th, 2012, about 7 member of the UCLA Anderson Student Investment Fund went to Orange County to visit a few investment management firms. The highlight was a visit with the star hedge fund manager Mohnish Pabrai, who took the time to talk to us and have dinner.
Some of Pabrai’s favorite principles:
1) Align your outer/performance self with your inner/real self. Basically, most people aren’t aligned with their gut/heart/subconscious beliefs and their explicit/stated/conscious beliefs and preferences. The “pipeline” from the conscious to the subconscious is clogged and you need to learn how to unclog it. It’s the difference between meeting a potential mate that meets all the boxes on your checklist, versus falling in love from your heart/gut. Ideally you have both aligned, like historical figures (Ashoka, Buddha, Jesus, etc.). One thing is to understand the inner map of who you are - everytime you do something or meet with someone, ask: “Did I really enjoy that?” If not, cut that activity or person out of your life over time. Test things but be honest. Streamline your life to things you are good at and where you add value (important to serve others and have a purpose). Great investors and traders like Buffett and Bill Gross do so well because they are more aligned than ordinary people - it’s not just cerebral smarts (both are geniuses, but many geniuses fail at investing) - it’s also emotional alignment with lots of rationality.
2) Tell the truth because it’s the rational thing to do and if you do it all the time you will increase alignment. If you are a honest truth-speaker you will attract similar people to you and increase your odds of succeeding. It’s OK to make a mistake and tell the truth, not OK to lie and cover it up. So if you run someone over accidently with your car, if you are truthful and contrite people will forgive you. Not so if you lie (examples of Teddy Kennedy and Bill Clinton lying about car accident and Monica Lewinsky). Even if you fool people rationally with your lying, their subconscious self will mark you as a phony. Complete candor is ideal. One example come from small, convenient lies. If your wife asks you what you think of her dress before you go to dinner, you can lie and save time. Or you can tell her the truth and lose time if she wants to change, but it will immensely help the relationship over time. All relationships and certainly all of business and finance is built on trust.
3) Copy, steal, and clone ideas and processes started by other smart people (if they make sense). Most people have a hard time copying due to ego.. they want to be original. The best businessmen were unabashed copiers, like Bill Gates, Sam Walton, Andrew Carnegie, etc. Microsoft was bad at copying and took their time, but they eventually got it “good enough” that they could crush competition with their capital and distribution ability. Even Picasso said: ”Good artists borrow, great artists steal.” In the investment context, this means you should identify star money managers and limit your set of ideas to what they are looking at (if you are small, herding here works). Spend a lot of time with 13Fs… it’s a large set of ideas to examine (10 managers with 20 large positions gives you 200 possible ideas).
4) Examine mistakes closely, both yours and others, and create a checklist to avoid common mistakes. The FAA does this after every plane crash and creates a checklist for pilots. We don’t do it for nuclear power plants since we don’t tolerate failure there… prob. too risk averse.
5) Reciprocity: Give first, and then later ask for help. Ex. of Hare Krishna people giving “free” flowers at airports and later asking for a donation. Pabrai sends investors a physical package of documents and a free, nice Cross pen ($50 value). He often sends books to his investors and gives people free stuff. Size of favors and calibration is important - the brain is bad at sizing. So a con artist can take advantage of this by doing you a small favor and asking for a big one… watch out for this and immunize yourself.
Pabrai’s Ideas on Investing and Portfolio Construction:
1) Concentration versus diversification: Pabrai went from 10 positions of 10% in his portfolio to about 20 positions of 2, 5, and 10%. He is more in the Seth Klarman camp and disagrees with Munger’s view that you should focus on your top 5 ideas. He says its a matter of personal risk preferences… it’s OK to do top 5 or 10, but you and your investors need to have the gut for the volatility. Most people don’t. So follow your comfort zone. If you have permanent capital, you can take a lot more volatility and be more concentrated. The 2% positions are for riskier, more option-like bets that could go to 0 or 5x return with a 50/50 odds… good bet with many of them done independently.
2) Pabrai’s investing style: Prefers deep value and looks at balance sheets and normalized earnings… doesn’t like growth stocks because harder to analyse and feel comfortable about the business and growth meeting elevated valuation. Still fairly concentrated, neutral between US and Intl. (but avoids countries with systemic accounting problems like China). Like small to mid cap Indian companies if you are on the ground there. Pabrai has a 90-point checklist from his own failures and systematically looking at investment failures of other top firms over the last 20 years. Every new investment will raise 10-15 red flags and 5-6 new questions from the checklist. You need to decide to invest despite the risks, or wait for another pitch. Pabrai has only part-time staff and no analysts - he does all the thinking himself and occasionally talks to industry experts and other great investors. His screens are: 13Fs of star managers, large % drops in price, unloved industries not in the news, etc. Avoids industries and sectors with a lot of change, like most tech. Always need to watch portfolio turnover and tax impact.
3) Research: Solely consists of reading 10-Ks and Qs and talking to industry experts. He wants to understand the business and industry.
4) Talking to management: Often a waste of time. They are great salesmen and will mislead you (even if they are honest, prob. too biased to optimism). Best managers are not working for $$ but for game and control… they are in their playground and church - they work for their mission and purpose. Just figure out if management is honest and will deal fairly with everyone, with an eye to protecting shareholders.
5) Reading people: Look at past track record… much better than resume. The ability to read people is a competitive advantage, but can’t be taught (it is innate or must be learned).
6) Mr. Market analogy of Ben Graham: Is completely correct… markets have a poetry.