Cloning Investments 101

Bizarro.jpg

Cloning Investments 101

Bowling with Bumpers

What and Why?

 

The concept of cloning investments is simple. You select stocks that have been purchased by investors that have extremely good long-term track records. We have come to strongly support this concept and the reason is simple:

When you only basically buy ideas that other great investors have already bought after studying them, the error rate you will have will be a small fraction of what you would have if you went out on the prairie on your own. If you go out on your own and look at 10,000 stocks and pick ten – trust me – your error rate will be off the charts. But if you pick ten out of the 40 that great investors have bought and you have looked into why they bought them, it’s like bowling with bumpers…Never bowl without bumpers when they offer you bowling with bumpers.
— Mohnish Pabrai, Ben Graham Value Investing Talk 2012

The approach he takes is straightforward.

[You can invest by] simply only taking ideas from great investors, studying them on your own … discarding the ones you don’t understand, take the ones that you really understand, take the ones that are absolutely no brainers, and buy those. And that will be enough to get you going for awhile. So I think the big message I wanted to just meet with you here is that cloning is extremely powerful. If you look at what I did with Pabrai Funds, the structure, the setup of Pabrai Funds – completely clone the model – and then on top of it when I’m actually buying stocks, very few of the ideas – and remember this is just between us girls here – very few of the ideas are actually things that I have generated on my own.
— Mohnish Pabrai

It is unbelievably simple and makes sense, but it is just hard to do emotionally. And it’s because we all believe – particularly A-types who plan to pick stocks to get rich – that we are all snowflakes with unique insights. Even us here – about half of one of our portfolios are not cloned ideas (and we have stubborn justifications for this).

There’s something in the human psyche and something in our evolution that makes us adverse to doing things the easy way or taking some simple ideas and just running with it….. The few of us who are able to, kind of, transcend that like Sam Walton and Bill Gates, etcetera, you get a massive advantage… In fact in the investing business you see this all the time – no one is willing to clone.
— Mohnish Pabrai

To be clear, this is not a “put your blinders on” approach, where you max out the portfolio on whatever Mr. B’s latest purchase is and hope for the best. It is about creating a systematic approach. Specifically, we advocate buying and selling a stock:

  1. based on following specific investors who have a very long track record;
  2. show conviction in their idea – demonstrated by being a large percentage of the portfolio, and;
  3. where it is a company you actually understand.

We cover these items in detail and have a full checklist in the Step-by-Step Guide below.

But how does this give you an advantage over the majority of investors, including those that also clone others?

I think the reason you will get an advantage is because most people don’t have the temperament or the patience. They may buy IBM because [Warren] Buffett bought it and it may get a bump in price, but they will not hold it until Buffett holds it. They will buy it in November 2011 and by February 2012 they have already sold it, made 10%, and said “I am such a genius”. And that’s the problem. Actually … this gene of cloning is very quirky – most people are willing to clone but only partially. They will buy what Buffett buys, a lot of people do that, but they don’t do the rest of it. That is stupid cloning. Half baked stupid cloning. We don’t want to do stupid cloning. You do it all the way.
— Mohnish Pabrai

The cloning technique relies on trusting who you are copying. How do we then identify the next funds to clone? What would you say that is the minimum number of years for you say is the minimum number of years that you would need to see strong performance to actually trust those to adequately copy them?

I would say that if you have 15-20 years of history behind people that is a pretty good indicator. And not only that, you look at the history and you look at their approach. What are they saying and how are they going about doing it … I think there are many really good investors.
— Mohnish Pabrai

Sometimes the SEC allows an investor to not file a purchase temporarily (as was done by Warren Buffett when he was buying $10+ billion of IBM). How does this affect your process?

Completely irrelevant. It’s like this. Let’s say you have all these stores you can walk into and look at everything about how they run their model. And one out of 200 stores is closed. That’s not a problem. We also do not know about foreign stocks in 13-Fs. We don’t know about things that they buy where the amount they bought is really small. If I buy something where I spend less than $200,000 it doesn’t get reported in the 13-F. Of course, you also have the secrecy rules.


I think that is not really relevant because you have such a huge canvas from which you can draw data from. And even for IBM [when the SEC allowed Buffett to delay reporting this position because of how long it takes Berkshire Hathaway to build a large position] – look at what happened after IBM stock after they said that Buffett bought it. Nothing happened. Maybe it had a 1% move or something. There wasn’t much movement. You had plenty of time after that to still act on it. And so I actually think that the fact that some small parts are hidden is irrelevant. You should just ignore that.
— Mohnish Pabrai

What constitutes understanding the business? How do you distinguish between thinking you understand the business and actually understanding it? How can you distinguish?

Charlie Munger says, to ask the question is to answer it. So basically, if you are operating within your circle of confidence you will not need to ask yourself “Do I understand the business?”

The moment you ask yourself “Do I understand the business?” you do not understand the business. So to ask the question is to answer it. If you are asking yourself the question you are operating outside your circle of confidence.
— Mohnish Pabrai

The Practical Guide to Cloning

Step 1: Read 13Fs

Oh America. The land of bureaucracy and disclosure rules.

In the United States, any institutional investment manager that manages over $100 million or more in Section 13(f) securities (explained below) must report its holdings on Form 13F with the Securities and Exchange Commission (SEC).

 

As defined by the SEC:

In general, an institutional investment manager is: (1) an entity that invests in, or buys and sells, securities for its own account; or (2) a natural person or an entity that exercises investment discretion over the account of any other natural person or entity. Institutional investment managers can include investment advisers, banks, insurance companies, broker-dealers, pension funds, and corporations.
The securities that institutional investment managers must report on Form 13F are “section 13(f) securities.” Section 13(f) securities generally include equity securities that trade on an exchange (including the Nasdaq National Market System), certain equity options and warrants, shares of closed-end investment companies, and certain convertible debt securities. The shares of open-end investment companies (i.e., mutual funds) are not Section 13(f) securities.
— Source: https://www.sec.gov/fast-answers/answers-form13fhtm.html

So what this means is that effectively every major money manager and firm has to disclose their holdings quarterly.

Filings can be found by going here: https://www.sec.gov/edgar/searchedgar/companysearch.html

Example: Mohnish Pabrai

Mohnish files under Dalal Street, LLC.

 

This, of course, is a lot of work.

There are two alternatives that we are aware of: Whale Wisdom and Guru Focus

Gurufocus has a nicer look to it and is quite easy to use. However, Whale Wisdom has some pretty snazzy paid packages if you are interested (including an Excel add-in). We don’t currently subscribe to either but have come across people who have to both, they seemed pretty happy (your mileage may vary).

https://www.gurufocus.com/holdings.php?GuruName=Mohnish+Pabrai

Step 2: Copy

Now, the following applies to those out there who really enjoy investing, have time do it, and have a desire to understand how things work. We have built the following simple mini-checklist to check copy ideas.

To properly copy, you need to buy ideas that:

1)      Are from a fund manager with a long history of success – 15-20+ years is ideal.

2)      Represent high conviction by the fund manager – Fiat represented ~60% of Pabrai Holdings’ US investments at the end of December 2017. This is definitely high conviction but very few fund managers run this concentrated. But realistically a meaningful hold – 20+% ideally, is sufficient to qualify.

3)      Can be bought at a price similar to what they bought it at – Mohnish bought Fiat in 2014 at an average price less than $8. Fiat currently trades at around ~$21. – Buying at 2.5x does not pass this test as their own investment thesis might not hold at this higher price from a risk/return standpoint. However, if they recently bought a meaningful additional stake recently (which does not apply in this case) that would be considered.

4)      Stick to your circle of competence – Focus on ideas you can understand and spend as much time as you can learning to increase your circle of competence.

Interested in more? Detailed case studies coming soon.