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Pabrai


Guest kumar
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Mohnish Pabrai has changed his investment strategy. He is no longer into concentrated portfolio and getting into commodities. Those who have not read his recent report, here is a link to an article about it:

 

http://biz.yahoo.com/indie/090219/1719_id.html?.v=1

 

 

...all changed in late 2008, when Pabrai saw that "good investment ideas were plentiful." In reaction, he adjusted his long-held "10x10" approach. "One needs to be a learning machine and be willing to give up some of our best loved ideas when the evidence suggests they are flawed. Going forward, to temper volatility, Pabrai Funds will endeavor to size positions at 2%, 5% or 10% of assets.

 

Pabrai's comments in his recent letter to shareholders noting "loads of deep value" in "metals, commodities, mining and natural resource companies.

 

Pabrai's interest in commodities was a surprise to me and I always wondered about investors with a highly concentrated portfolio (Pabrai and Berkowitz in particular. Now Pabrai is out, Berkowitz is next?). Like to hear your comments. Have you also changed your stategy after the recent meltdown?

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Counter-intuitively, I am going long highest quality and generally higher P/E stocks.  E.g. KO, JNJ, some BRK, that type of thing - trying to get them near their lows.  Staying out of small cap for now.  Eyeing up eBay.  Picking up these things but my main position remains ORH. 

 

Remaining hedged and expect quality and ORH to outperform the indices.  Also looking at debt.  Bought a bit of gold - don't ask me why, I'm not an expert but it just felt right as the US dollar seems to be the strongest currency right now and that just isn't right.

 

Jeremy Grantham expects quality to outperform despite higher P/Es in a calamity (a calamity as opposed to just another recession and a normal stock market decline).  Watsa seems to be doing some of this as well.  Buffet alway buys quality at a decent price.  Julian Robertson is buying high P/E stocks as well.

 

There is no risk KO cuts its dividend.   

 

 

 

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On Friday I also bought a small position in BRK.B and smaller in Wells Fargo - WFC. I am debating if I should increase BRK to 10% of my net worth. If it sells off, I would double up. Rather than pick up the individual names (i.e. WFC) just go with BRK at current prices.

 

FFH also got my attention today.

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someone needs to explain why gold is  worth 3x what it was worth in 2003, I know the world is ending but really whats the fascination?  Also why does the U.S government continue to hold gold if its not there to back up the currency, why no fort Knox etf? 

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Guest kawikaho

I would not touch WFC with a 10 foot cattle prod after BAC and JPM cut their dividend big time.  Also EBay lost the war to AMZN.  If you're looking for quality, buy AMZN.  Ebay sucks.

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Jack,

 

Your response is not inappropriate, but if I've read it correctly, it is a little sarcastic.  This is an area where we collectively need to be a little bit careful as Sanj has created this area for us to have thoughtful, courteous discussions about markets and investing.  Sarcasm can be a very effective communication technique, but it can also be perceived as belittling.

 

That being said, there are many arguments for and against a purchase of WFC.  It doesn't strike me that the fact that BAC or JPM cut their dividends would have any impact on WFC's intrinsic value.  Perhaps it could be argued that WFC may follow suit, which could cause the share price to temporarily tumble...but a more fulsome explanation from kawikaho would clarify why he doesn't want to touch WFC...and then we could thrash out that discussion based on its merits.

 

SJ

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Guest JackRiver

StubbleJumper

 

Point taken.

 

Quick question for you, how does the suspension of a dividend change intrinsic value?

 

Yours

 

Jack River

 

 

 

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That being said, there are many arguments for and against a purchase of WFC.  It doesn't strike me that the fact that BAC or JPM cut their dividends would have any impact on WFC's intrinsic value.  Perhaps it could be argued that WFC may follow suit, which could cause the share price to temporarily tumble...but a more fulsome explanation from kawikaho would clarify why he doesn't want to touch WFC...and then we could thrash out that discussion based on its merits.

 

I think though, that as value investors it's important to take price movements into consideration when looking at banks. Normally, we're quick to reject sharp downswings in prices when we look at businesses, especially when we have an idea of what intrinsic value is. But banks on the other hand are a bit different, downswings in a bank's stock price can affect the confidence behind them, which is inherently a driver to intrinsic value due to their deposit base.

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...all changed in late 2008, when Pabrai saw that "good investment ideas were plentiful." In reaction, he adjusted his long-held "10x10" approach. "One needs to be a learning machine and be willing to give up some of our best loved ideas when the evidence suggests they are flawed. Going forward, to temper volatility, Pabrai Funds will endeavor to size positions at 2%, 5% or 10% of assets.

 

Pabrai's comments in his recent letter to shareholders noting "loads of deep value" in "metals, commodities, mining and natural resource companies.

 

 

If I understand him correctly, he's saying that because the number of ideas has increased, he's therefore going to run a more diversified fund.  Why wouldn't you still purchase your 10 best ideas, and simply enjoy the greater future returns because they are that much cheaper?

 

How does the increase in number of good investment ideas warrant more diversification?  I suspect that he's trying to explain away poor performance with a non sequitur.

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If I understand him correctly, he's saying that because the number of ideas has increased, he's therefore going to run a more diversified fund.  Why wouldn't you still purchase your 10 best ideas, and simply enjoy the greater future returns because they are that much cheaper?

 

I think arguments can be made for either being more concentrated or more diversified in the presence of more bargains.

 

Here is the argument for being more diversified: On a purely mathematical basis, the more bargains (investments with higher expected return), the more you should be diversified. In other words, when you can only find 10 investments that are trading at 50% of value, you should be concentrated in those holdings. But if you can find 30 investments for 50% off (assuming you have the same level of conviction), you should invest in all 30 of them. This can be shown using the Kelly criterion.

 

Also, when on average everything in the market is relatively cheap, it's much easier to throw darts and still be successful. If you are somewhat diversified, you're going to have good long-term returns, and little risk of permanent capital loss. With extremely cheap securities, it's hard to determine what's the "best" buy: a 30 cent dollar, or a 35 cent dollar. It's splitting hairs.

 

So, that's an argument for more diversification. A more focused portfolio in a few investments where you have a lot of conviction in also makes sense. (Especially for individuals who don't have to worry about short-term investor withdrawals).

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If I understand him correctly, he's saying that because the number of ideas has increased, he's therefore going to run a more diversified fund.  Why wouldn't you still purchase your 10 best ideas, and simply enjoy the greater future returns because they are that much cheaper?

 

How does the increase in number of good investment ideas warrant more diversification?  I suspect that he's trying to explain away poor performance with a non sequitur.

 

Our funds will remain very concentrated.  But there are some aspects of what Mohnish is doing that is just logical.  For example, we have bought distressed debt for the U.S. fund, and income trusts for the Canadian fund.  In those circumstances, you are better off buying a small basket of ideas at relative yields, then concentrating on just one or two. 

 

In the past, when we've had a highly concentrated fund, it was because ideas were not plentiful.  You really had to dig around for ideas.  Today, you can find multitudes of ideas that are trading at huge discounts to their net asset value.  Instead of having a fund in say 7-8 ideas, we have closer to 12-14.  But we aren't going from 7-8 ideas to 25-30 ideas.  We think that's just wasted effort. 

 

At the same time, we would be hesitant to ever go back down to just 4-5 ideas, except for our own corporate accounts where we have just 4 ideas where all the capital is invested.  That's because the retail investor, be it in mutual funds or hedge funds, just don't have the stomach for this type of environment where their portfolio could be down 50%.  It is simply too much for them!

 

I think that is really the primary driver behind Mohnish's decision.  I can only imagine the hell he's been going through dealing with his partners, who are going through their own equally scary hell of seeing their investments down 60% in the last year and half.  I would suspect that's the part that drove Mark Sellers to close his fund as well.  Human psychology does not change.  No matter how much an individual says that they can handle volatility, only the truth becomes clear when the actual crisis appears.  And not only retail investors.  There are alot of investment managers who can't handle the swing as well.  I think many will never re-enter this business after what they've experienced.  Cheers! 

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Here is the argument for being more diversified: On a purely mathematical basis, the more bargains (investments with higher expected return), the more you should be diversified. In other words, when you can only find 10 investments that are trading at 50% of value, you should be concentrated in those holdings. But if you can find 30 investments for 50% off (assuming you have the same level of conviction), you should invest in all 30 of them. This can be shown using the Kelly criterion.

 

How does the Kelly criterion help determine this?  I thought it helped you place the appropriate wager given the varying odds among bets of a certain sample size.  It doesn't help you determine the sample size, does it?

 

Or were you referring to the fact that diversification reduces the impact of incorrectly estimating the payoff of a single bet?

 

Appreciate your comments, and all others as well.

 

E

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Quick question for you, how does the suspension of a dividend change intrinsic value?

 

Jack,

 

I would suggest that suspending the dividend doesn't really change the intrinsic value of an enterprise unless 1) it permits highly profitable incremental  investments that could not otherwise be made due to capital constraints, or 2) the suspension avoids the need to issue additional shares at a price below intrinsic value per share.

 

However, that doesn't meant that the market price won't tank following a dividend suspension.  Norwegian widows seem to have a strange love for their dividends and may take strange actions when they are chopped!

 

A third possibility has been brought up, which is that chopping the dividend may result in a plummeting share price...which in turn may result in a loss of confidence in the bank which may have an impact on its operations and thus intrinsic value.  However, I'm not quite sure that I buy that argument.  You and I (and everyone on this board!) pay attention to stock prices, but does "John Q. Account-holder" pay any attention at all to the price of his bank's shares?  This certainly has not been my experience -- I have friends and family who are decidedly unsophisticated consumers of financial products and barely understand the extent to which they are being hosed by their bank....and they certainly don't watch its stock price!  Do the ratings agencies care if the dividend is chopped?  I would say they would usually view it as a necessary move and a positive step!

 

SJ

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How does the Kelly criterion help determine this?  I thought it helped you place the appropriate wager given the varying odds among bets of a certain sample size.  It doesn't help you determine the sample size, does it?

 

The Kelly formula shows what the optimal % to put in a certain bet is based on the outcomes & probabilities. But, it can also tell you which (or how many) investments to make (not necessarily the sample size). The "goal" of the formula is to maximize the geometric mean return of the portfolio as a whole.

 

The commonly used example is a coin where heads yields a 3x return and tails is a complete loss. So if the coin flip is the only investment available, the formula says to put 25% in it. If you have three of the same coin tosses (each with independent outcomes), it says to put about 21% in each, with 37% in cash. If you have 100 of the same tosses, you should put 99.x% of the portfolio into all 100 tosses. Not 100%, because there is still and extremely small chance that all 100 will come up tails.

 

The more bets you can make (assuming they have the same odds/outcomes), the higher the mean return for the entire portfolio.

 

Obviously, the investment world is much more complicated and uncertain, but the same theory still holds. It seems like this is the basic argument that Markowitz uses in favor of diversification. But where it breaks down (which Buffett and other good investors know) is that it is incredibly difficult to find a lot of good investments. So the Buffett's of the world sacrifice more diversification for having better conviction and confidence in the few investments they do make. It's a tradeoff every investor needs to make. Those are my thoughts anyway.

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I would like to emphasize that we aren't talking about just volatility here.  Instead, in too many cases, we are talking about permanent loss of capital for investors: that capital is gone and the market will not gain 100% in short order to make up for the 50% drop back to these more normal valuations for equities.

 

Too many value investors became relative investors.  Unfortunately, they were focused on performance relative to a benchmark that was a clear bubble to anybody paying attention and with some sense of market history.  They were unaware of, or ignored, that risk - the risk of poor absolute performance in order to chase that benchmark - and now they face their legacy of providing multi-year losses for their investors. 

 

There were too many of these types of investors and not enough folks focused on protecting the downside.

 

 

 

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Guest kawikaho

Sorry guys.  I'm still new to the board and getting adjusted to its culture, rules, etc...   Sorry for the extremely brusque retort regarding WFC and Ebay.  I think WFC is one of the most solid of the big banks out there.  I bought it when it declined to 20 and sold at 30 on the second go around.  This was after I discovered Warren Buffet bought it in his own personal portfolio for around 20 during the first time it reached 20.  It gave me the self confidence to bet big on it when it dipped back to 20 again.  My feelings were that the price of the stock went up quickly in a short amount of time, so I sold.  I never thought it would go back to 20 after I sold at 30, but it did.  I was tempted to buy again, but the market was telling me something: danger.  Why is it back to 20 again so quickly?  After it broke 20, there was news that BAC would have to cut its dividend.  That was the biggest problem for me.  Without the dividend, it's like having cake without the icing.  That was when WFC was around $18.75.  I've been telling people that WFC at 20 was an excellent buy, but when BAC cut its dividend to $.05, I said all bets are off.  Meredith Whitney was also saying WFC is attractive at $20, but I think she has changed her tune lately with all the big dividend cuts in the common.  I've been watching WFC go from 19 all the way to 11.  I also believe FBR's report that WFC will have to cut its dividend.  Right now, i'm inclined to watch WFC.  I still think it's the strongest of the banks, but to me that's like saying it's the nicest tasting lemon out of the bunch.  Sorry if my logic and analysis doesn't fit will with the rigorous value approach of the board.  I'm still learning as I go along.

 

As for Ebay, I used to think Ebay might make a good buy.  I've asked my cousin his thoughts, since he used to work there, and he's very much in tune with the culture of technology.  He told me flat out that Ebay is being dominated by Amazon.  I agreed.  I used to Ebay way back in the day, but I found that for most stuff, it was just as cheap, or cheaper, to buy it from Amazon-- and you get this without all the hassle of bidding, waiting, fighting for the best price.  Also, Amazon did the right thing by building out its massive infrastructure early on.  It took on huge debt by doing it, but ultimately it has something that is lost with most Web 2.0 businesses: brick and mortar.  The argument that most analysts made for Ebay turned out to be its weakest point: the lack of real estate and costs makes it highly profitable and a better business model than Amazon.  Now, Ebay is fighting to retain power sellers as Amazon has all the infrastructure to help them ship, store their goods near POS warehouses, and do this for much cheaper than Ebay.  Also, Amazon being the 800 lb Gorilla has huge deals with major suppliers to undercut most retailers and even Ebay.  It's just no contest.  I've also recently tried Ebay again to sell some stuff along with Craigslist (which is what i've mostly used to sell stuff), and Craigslist won hands down.  It's so much easier, cheaper (for free), and painless to sell with Craigslist than Ebay.  I can easily adjust prices and find what the market is willing to pay for the item.  The same item that would barely sell on ebay for 500, I was able to sell for $850 on Craigslist.  I think Ebay, like Yahoo, has dwindling pricing power.  I wouldn't buy either for the long term, but on some short term speculation?  Probably.

 

 

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As 'seasoned' value investors we know that concentrated portfolios contribute to volatility, you need long-term stable & knowledgable investors, & you have to be able to tolerate -30+% returns for extended periods. In many ways its a strategy better suited to private vs public money - & public money is extremely nervous at this point. The marketing need essentially dictates the change.

 

The # of ideas held at any one time is also not static. We too currently hold more ideas than we normally would, & an execution bias in favour of funds vs individual securities(diversification, liquidity). Times change, & we need to change with them.

 

SD

 

   

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kawikaho,

 

 

I haven't read all your posts and therefore don't know how hard your tone was, or whether it was even out of line.  Just based on this last answer however, I like what you are bringing to this board:  I also don't believe that pure fundamental analysis is optimal when investing.  All too often, we find that Mr. Market is behaving "strange", yet in a fairly predictable manner.  In particular, I have seen too many stocks trend down in spite of great prospects - just look at what FFH has done since last week, or what Quadra Mining did in 2008, or even what BRK has done over the past few months in spite of WEB's amazing investment acumen.

 

 

We have a lot of very good members here, some of whom are a little opinionated (hi Sanj & Ericopoly  ;D); more than anything though, we are here to learn and profit.  Dissenting can be good.

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I think he is talking about flawed ideas (investment ideas) here...not the concept of concentration.

 

I think he got burned by DFC (as did I... teach you to follow blindly) and realized that his ideas are not 100% flawless (or anywhere near, even with the best of the best) to concentrate like he used to.  Couple this with the Kelly discussion above, and he's diversifying a bit more to play it safer.

 

The question that I pose is, is Buffet diversifying w/ his deals regarding gs, dow, etc, or asked another way if there were a opportunity that is big enough, would he be comfortable sinking all his current cash into it.

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