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Top U.S. Holdings of Pabrai Fund

(as of Sept. 30, 2014)

 

Horsehead Holding (ZINC)

Bank of America (BAC)

Citigroup ©

Posco (PKX)

Berkshire Hathaway (BRKA)

 

Q&A

Buffett Disciple Mohnish Pabrai on Bank of America, Citi, Google, and Hyundai

Hedge fund manager Mohnish Pabrai sees value in big financial stocks, Google, and Korean shares.

 

By JOHN KIMELMAN

Dec. 9, 2014 7:37 a.m. ET

 

In seeking out the advice of professional stockpickers, it’s best to avoid the so-called closet indexers.

 

Portfolio managers that fit that bill hold 40 or more stocks -- many hold hundreds -- with each comprising a small percentage of the portfolio. They collect active-management fees for performance that, at best, matches the index.

 

That’s not the way hedge fund manager Mohnish Pabrai rolls. The Indian-born Pabrai, who runs the $700 million-asset Pabrai Investment Funds, puts big money behind his convictions. In the investment world, that translates to holding a small basket of stocks and watching them closely.

 

“I have heard [Warren Buffett’s business partner] Charlie Munger more than once say that a well-diversified portfolio needs four stocks,” says Pabrai, in a phone interview from his office in Irvine, Calif.

 

Pabrai’s portfolios aren’t quite that concentrated. But the value hound is OK with buying a stock that makes up 10% of his fund house’s assets, and even letting it run a bit higher than that. He takes a go-anywhere approach, seeing opportunities ranging from the U.S. to South Korea.

 

A former information technology consultant, Pabrai is a serious student of Warren Buffett’s approach to investing. In 2008, he and a friend, value investor Guy Spier, paid $650,000 in a charity auction to have a two-and-a-half-hour lunch with their investment idol at a famous New York steakhouse.

 

It’s hard to know the full extent of Pabrai’s performance over the years. By law, as a hedge fund manager, he is not allowed to publish or disclose numbers for noninvestors, including inquiring reporters, since that constitutes marketing the fund. According to BarclayHedge, an Iowa-based fund-tracking firm, Pabrai Investment Fund 3 returned an annualized 9.68% over the past 10 years through Oct. 31 net of fees, outpacing the total return of the Standard & Poor’s 500 index by about 1.5% a year. That said, the fund has sharply underperformed the broader stock market this year.

 

When asked about this underperformance, he replied, “I think it is an irrelevant data point. There is nothing intelligent that one can say about short periods like 10 months. I never make investments with any thought to what will happen in a few months or even a year.”

 

At least investors don’t get charged for periods of poor performance. Unlike most hedge fund managers, the long-only investor doesn’t charge a flat management fee of 2% on top of performance fees. He just charges 25% on gains made over 6%.

 

He can keep his fees so low because of his low overhead; the 50-year-old does all the stock research and portfolio management himself.

 

When Barrons.com last spoke with Pabrai almost 10 years ago, he said active stockpickers should focus on small-cap stocks because it’s easier to find mispriced assets in that sector than it is with larger stocks.

 

Since then, he’s modified his stance to take advantage of a few big banks that he believes were unfairly beaten down during the Great Recession.

 

The bottom-up investor says he’s having a tougher time finding value in the U.S. stock market than he did a year ago. One of his favorite stocks is one he doesn’t own, at least not yet: Google (ticker: GOOGL).

 

Though he shies away from discussing stocks he’s been buying recently, his insights can inform those who are making their own decisions. Read on for his latest thoughts about the markets.

 

Barrons.com: Would you say it is easier or harder to find cheaply valued stocks than it was, say, a year ago?

 

Pabrai: I would say it’s harder. We haven’t had any meaningful investments in U.S.-listed stocks in probably two years. I’ve found a few things, but they are just really small. The stocks that we have found of any meaning are all out of the U.S.

 

Q: Where?

 

A: I’ve found stocks in India, China and South Korea.

 

Q: Can you elaborate?

 

A: I can discuss names that we’ve held in the past, but in general I prefer not to talk about my current stocks.

 

Q: You told me when we talked in 2005 that you tend to shy away from large-cap stocks because there is less opportunity to find mispriced assets. But I noticed in a recent 13F filing that one of your funds has sizable positions in two big banks, Bank of America ( BAC ) and Citigroup ( C). Explain this?

 

A: My feeling is that if a bank has proper reserves and it’s trading well below tangible book value, that is an undervalued bank. You could shut down a bank today and if the reserves are correct you would get back the tangible book value. So you look at something like Bank of America, for example, the tangible book value of Bank of America is around $14-$15 a share, and when we were making the investment it was around $6 to $7 dollars a share. It was trading at half of book value, and, of course, clearly at that point the market believed that book value was incorrect.

 

Q: So you thought that was a rare case where a large well-followed bank wasn’t being efficiently priced by the market?

 

A: Yes. It’s true that with large-cap stocks, there is less opportunity. But in a situation where there is a national crisis, things are beaten up so badly.

 

Q: When did you do most of your buying of Bank of America?

 

A: Around late 2011. I bought it right after Buffett bought it.

 

Q: Does what you say about BofA apply to your investment in Citigroup as well?

 

A: Yeah, I think it applies. Both were sitting at massive discounts to tangible book value.

 

Q: Are both Bank of America and Citigroup worth buying at their current prices?

 

A: Yes, both are undervalued. Eventually they should trade like Wells Fargo and JPMorgan with similar price-to-book and price-to-earnings multiples.

 

Q: I know you like India, South Korea and China. Are there certain national markets that you are particularly bullish on now or is your focus purely on businesses, not markets?

 

A: In the case of Korea, a lot of companies have preferred securities, and in many cases they are trading at 50% of common stock. There are hundreds of these preferreds. We are currently invested in Hyundai preferreds.

 

Q: In analyzing a business, are you also analyzing the country where the business is based?

 

A: Yes. For example, no matter how cheap it gets, we will not invest in Russia. There’s a lack of respect for capital. The same applies to Zimbabwe.

 

Q: When we chatted nine years ago, you said that you basically avoided retail and technology stocks because companies in those industries have a hard time maintaining a competitive advantage. As examples, you referred to Google and Microsoft ( MSFT ), saying that these stocks are priced by the market as if they were going to be around and successful for many, many years and who’s to say that is going to be the case.

 

A: I would say, in hindsight, it was probably a mistake that we didn’t buy Google. I don’t put Microsoft in the same category. I have no interest in Microsoft. But Google is probably the greatest company ever created in the history of mankind. This is a business that is highly innovative, and they are able to nurture businesses in such a wide range of stuff in such huge markets. As for Microsoft, at best they can copy someone else and after the seventh or eighth version they might get it.

 

Q: But does Google meet your value imperatives?

 

A: It is actually not an expensive stock, especially when you consider that reported earnings are severely understated because they are investing [heavily] in all of these endeavors.

 

Q: Is it safe to say that you wish you had bought Google nine years ago?

 

A: Absolutely. I’m saying I should buy it today.

 

Q: What about Apple ( AAPL )?

 

A: Apple also is a phenomenal company, and I think Apple will continue to grow and flourish even with Steve Jobs no longer in the picture. We are seeing a huge amount of respect for the company, and lots of good things are going on. But it is nothing like Google. They cannot do innovation in so many businesses.

 

Q: But for all the supposed advantages that Google possesses, Apple has been the far better investment over the last decade.

 

A: Yes. But what we are concerned about is the next 10 years. If I were betting on a horse between the two, it is a no brainer that it would be Google. In fact, if you told me the horses to pick from were Amazon.com ( AMZN ), Google, Microsoft, Apple, and whatever other names you had, I’d pick Google.

 

Q: Thanks for your time.

 

Comments? E-mail us at editors@barrons.com

 

Manager’s Bio

 

Name:  Mohnish Pabrai

Age:  50

Title:  Principal, Pabrai Investment Funds

Education:  B.S. in computer engineering, Clemson University; studied for master’s degree in electrical engineering at Illinois Institute of Technology

Hobbies:  Playing bridge 

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Thanks for the article. I thought his performance was something like 25% or something crazy?

 

I believe the gap between the perceived and real is why getting a hold of his letters is impossible.

'

 

Yeah, Nate. I just don't know man. I like Pabrai from everything I've read. He seems really smart and cool. With that being said, a 1.5% outperformance of the S&P 500 over 10 years is good but not outstanding, especially when one figures taxes into the equation (and the roughly 70% drawdown). I'm guessing the article is incorrect or else Eric wouldn't have invested with him.

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I read and posted this interview right before bedtime (where I live) last night.

 

Now that I've thought it over, some thoughts:

 

1. Pabrai says that he won't invest in Russia at all due to lack of respect for capital. But he's happy to invest in India. So there must be some dividing line somewhere, not just an all or nothing decision. I wonder where that is.

 

2. Pabrai's analysis of Google seems extremely shallow.

 

3. Pabrai says that he will not discuss current holdings, and then does so. This also seems at odds with his behavior in giving a "stock tip" to buy GM-WSB.

 

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Thanks for the article. I thought his performance was something like 25% or something crazy?

 

I believe the gap between the perceived and real is why getting a hold of his letters is impossible.

'

 

Yeah, Nate. I just don't know man. I like Pabrai from everything I've read. He seems really smart and cool. With that being said, a 1.5% outperformance of the S&P 500 over 10 years is good but not outstanding, especially when one figures taxes into the equation (and the roughly 70% drawdown). I'm guessing the article is incorrect or else Eric wouldn't have invested with him.

 

I agree, I have a lot of respect for the guy.  He gives great talks and seems like a really nice guy.  But something in this interview sent up red flags for me.  Saying it'd be illegal to discuss performance is weird, if he were up 30% this year would it be illegal?  So many managers openly discuss how they've done for the year, it doesn't seem like an issue.

 

One of his talks really helped me understand marketing in a new light, for me the talk was invaluable.

 

Here's the rub for me.  Everyone will underperform at some point, it's just how it works.  So he's underperforming this year, big deal.  But just come out and say that and move on.  We can't control when what we own realizes fair value.  All we can do is buy and wait.  I don't like how he was trying to dodge the question on some weird technicality.

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Thanks for the article. I thought his performance was something like 25% or something crazy?

 

I believe the gap between the perceived and real is why getting a hold of his letters is impossible.

'

 

Yeah, Nate. I just don't know man. I like Pabrai from everything I've read. He seems really smart and cool. With that being said, a 1.5% outperformance of the S&P 500 over 10 years is good but not outstanding, especially when one figures taxes into the equation (and the roughly 70% drawdown). I'm guessing the article is incorrect or else Eric wouldn't have invested with him.

 

I agree, I have a lot of respect for the guy.  He gives great talks and seems like a really nice guy.  But something in this interview sent up red flags for me.  Saying it'd be illegal to discuss performance is weird, if he were up 30% this year would it be illegal?  So many managers openly discuss how they've done for the year, it doesn't seem like an issue.

 

One of his talks really helped me understand marketing in a new light, for me the talk was invaluable.

 

Here's the rub for me.  Everyone will underperform at some point, it's just how it works.  So he's underperforming this year, big deal.  But just come out and say that and move on.  We can't control when what we own realizes fair value.  All we can do is buy and wait.  I don't like how he was trying to dodge the question on some weird technicality.

 

The interview said "Pabrai Fund 3" had 9'ish percent returns -- aren't there 5 funds, hence the name "Pabrai Funds"? To get an idea of what his returns are you need to have numbers from all of the funds. A rough proxy for this is to look at the size of his fund over time. It's at $700 million now, and he started with $8 million 15 years ago. I don't think he's raised much more money since then aside from Dhando, which isn't included in the 700 million figure. I'm writing from my iPad so I can't easily calculate it, but that growth feels inline with his claims. 

 

Also I do understand and agree with his stance on not discussing his holdings. He's cloning Buffett, who doesn't discuss his holdings, because he doesn't want to answer constant questions from investors about them, which might cause him to second guess his decisions, especially at the worst times for the position, which is when questions are most likely to come in.

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It appears obvious to me what is going on with Pabrai.  He has spent some time on the PR for his image and fund holdings.  Whether that involves putting the stock symbol for his biggest holding on his license plate or having Barron's put a cover story on some obscure resource company ZINC, it seems like he is making the transition to monetizing his reputation.  Odd for someone who says he doesn't care what a stock does in a few months or even a year.

 

I would be curious to see how much profit he has generated for investors versus just percentage returns.  The more time I spend in the professional investing world the more I realize how much of it is an AUM/sales game, results be damed sometimes.

 

As far as not discussing his holdings, give me a break.  The guy bikes around with every stock symbol of his holdings on his body.  So I see him biking down the street am I not supposed to ask, what do you think of GM or FCAU?  I suppose his response would be, sorry I can't discuss my holdings?  Then why tattoo them onto your license or biking gear?

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The interview said "Pabrai Fund 3" had 9'ish percent returns -- aren't there 5 funds, hence the name "Pabrai Funds"? To get an idea of what his returns are you need to have numbers from all of the funds. A rough proxy for this is to look at the size of his fund over time. It's at $700 million now, and he started with $8 million 15 years ago. I don't think he's raised much more money since then aside from Dhando, which isn't included in the 700 million figure. I'm writing from my iPad so I can't easily calculate it, but that growth feels inline with his claims. 

 

 

Correct, although I do have his performance numbers for each fund.  So it isn't as much extrapolating verses looking at them.  I don't know how he's done in 2014, but if he's not having a good year the 9%-ish returns annualized make sense.

 

He had a fund from 1999-2002 that did 21% annualized, maybe that's where the returns of 20% plus come from?  I believe that was his own money thought, so not sure if any investors participated in that.  Some of his funds have done well, they've all beaten the benchmark, which is the name of the game if you're in asset management.

 

The guy is very smart and very savvy.  Like Picasso said he's clearly cloning Buffett in more ways than one.  The biggest is he's monetizing his reputation and connections to grow his capital base.  He purchase the insurance company and now has this platform to grow on.  If he wanted to do 25% annually and kill it on performance he's not going to raise capital, he'd stay small.  But he has said he wants to be a billionaire, you don't become a billionaire by returns alone.  You do it by besting the index and raising funds and earning fees from said funds. 

 

I have no doubt he'll reach his goal someday.  Kudos to him, hopefully he can enjoy it.  I think from where we sit it looks like he's invented a perpetual motion machine, this thing that just spits off cash with no work.  But my guess is he works much harder than anyone imagines.  I think the afternoon naps and biking are the narrative he wants, just like Buffett wants to be this nice old grandfatherly figure, not a ruthless investor.

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It appears obvious to me what is going on with Pabrai.  He has spent some time on the PR for his image and fund holdings.  Whether that involves putting the stock symbol for his biggest holding on his license plate or having Barron's put a cover story on some obscure resource company ZINC, it seems like he is making the transition to monetizing his reputation.  Odd for someone who says he doesn't care what a stock does in a few months or even a year.

 

I would be curious to see how much profit he has generated for investors versus just percentage returns.  The more time I spend in the professional investing world the more I realize how much of it is an AUM/sales game, results be damed sometimes.

 

As far as not discussing his holdings, give me a break.  The guy bikes around with every stock symbol of his holdings on his body.  So I see him biking down the street am I not supposed to ask, what do you think of GM or FCAU?  I suppose his response would be, sorry I can't discuss my holdings?  Then why tattoo them onto your license or biking gear?

 

I totally agree with your sentiment. Firstly, Pabrai is a great PR man. You google his name and you'll see something like crushed the market by 1100% since inception. So he has no problem people touting his returns pre-2007 but now? He keeps his returns close to his chest. I read somewhere (maybe here) that he beat the market by 10% or so last year. So again he lets it leak when it promotes him. But this year up to sept his return is -3.4%, no wonder he is so tight lipped!!!

 

And you have to look at it another way. We all know his portfolio from SEC filings, it contains stocks that every value investor and his mother is bullish on: BAC, C, GM, the only unusual name is ZINC. Now he is saying you have to think differently to achieve different results. How can he crush the market with such a vanilla portfolio. And about this ZINC investment, it isn't some brilliant insight into the stock. He is making a bet about some new plant, and the plant isn't working out so well.

 

Also, while I am at it, he also contradicts himself. He used to say that he wants to have some big portion in cash cos that was his mistake in 2008. But now in his recent speeches he says he is okay with volatility, hmmm he seems to have a very short memory.

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In fact, this is one of the top Google results for "Mohnish Pabrai" for me (probably because I've read that blog before or favorited it...):

 

Mohnish Pabrai | Base Hit Investing

basehitinvesting.com/category/superinvestors/mohnish-pabrai/

Currently viewing the category: "Mohnish Pabrai" ... Mohnish Pabrai is one of my favorite current value investors to follow. He has one of the best track records ...

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His results were presented in some of his presentations.

 

After playing with some figures I think the 9,x %/year compounded return over the last decade is consistent with the 25+%/year he claims he made over the complete period (18,25 years).

 

The last decade includes his worst years, and excludes his best years. That's the the reason for this perceived contradiction.

 

If one only looks at the years he managed the funds (thus excluding the 4,5 phenomenal years at the beginning where he managed his own money), I think his gross return should be around 18%/year, depending on his returns since half 2013.

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One can learn a lot from Pabrai from his talks.

 

- He runs a concentrated portfolio, roughly 10 positions at 10%. (After financial crisis he diversified more, now back to it)

- Long multi-year holding periods

- Concentrated portfolio means large variation in returns and large influence of start and end dates for performance calculation

- Not afraid to admit mistakes and change his behavior

- Fair compensation with 25% above 6%

- Very low overhead and expenses

- Runs a successful foundation helping very poor people get into IIT with amazing passing rates

 

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Not sure about you guys but I feel I have picked up a lot about investing and life listening to Pabrai. He committed to give away 2% of his net worth every year to charity!!!! Not speaking about anyone else, I am certainly not at a point financially or emotionally where I can get myself to make the same commitment. This wins my respect for him.

 

I see him as a focused and smart individual that is willing to put in the research and go to the depths to answer questions like how to construct a portfolio (2x, 3x...), the investments process to follow (checklist) and others.

 

Is he perfect?  No....he is human!

 

Regarding the question about his returns for 2014 in the interview, how would you expect Buffet to answer that question? There have been stretches where Berkshire has lagged the index for multiple years only to be proven right over time.

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