Mohnish Pabrai’s 2012 talk at the Ben Graham Centre of Value Investing - Key Points

The following is a post of the key points of Mohnish Pabrai’s 2012 talk at the Ben Graham Centre of Value Investing (link below). Pabrai is the Managing Partner of the Pabrai Investment Funds, where he primarily “clones” the strategies and purchases of other investors by looking at their SEC required 13F disclosures. Since inception in 1999 with $1 Million in assets under management, the Pabrai Funds grew to $600 Million in assets under management in 2011. A $100,000 investment in Pabrai Funds at inception in 1999 would have been worth $809,800 as of March 31, 2011 – an annualized gain of 19.5% (versus 3.3% for the Dow).

·Charlie Munger created a lattice work of mental models and has spent lifetime building them.

o   Mohnish models – Started with Tom Peters who was “Jim Collins” of 1980s. Manager guru, wrote several books including In Search of Excellence. One story stuck out to Mohnish à the Gas station story – Two gas stations were diagonally across from each other, both self-serve. At one of the stations the owner would come out once an hour and pump their gas, clean window, service, at no charge. Owner across the street sees and says this is stupid you cannot do it for everyone, why do it for anyone? This manager never made changes. Over time guy providing extra service got more business. Competitor still had no change in behavior. Tom Peters said you can lay out your trade secrets completely to competitors; it will make no difference because they will not listen to you. Mohnish said he would prove Tom wrong by 1) forcing self to take ideas from customers and 2) I will observe in business when I see examples of people quoting good ideas. Mohnish gave competitors candid answers for how he was doing what he was doing and they haven’t acted on his comments.

o   On Innovation: Sam Walton – Not a super competitive smart guy, just spent time in competitors stores. There was no innovation, just copying all competitors. He added very little innovations. Microsoft – Never produced innovative ideas that have made money, money maker is cloning (not even very good at it, 8-9 attempts). McDonalds – precise approach for finding new locations. Burger King has two guys that figure out locations, they put Burger Kings next to McDonalds.

·Warren Buffett partnerships, cloned his - Came across Buffett in 1994, started investing w/ $1MM. Started fund in 1999. Went to set up partnership, copied Buffett’s 1956-1969 partnership. The Buffett partnership ended in 69, his started in 99, he could not find any fund in between using the Buffett approach using the partnership. Validation of Tom Peterson thesis that people don’t copy others. No management fees, 6% hurdle w/ 25% after, reporting once a year. This did not exist at the time. Gave him a moat as large firms would have management fees.

·Buffett - He does not delegate any part of the investment process. 100% of the work is by him. With no staff you have no expenses, can get away with charging no management fee. Competitors have large staff “and not sure what they do all day”.

·Charlie Munger/Buffett - have met them and quizzed them (particularly Munger).

·Investing style – If you know nothing, you can index and do better than the village idiot. With IQ of 70 you can buy BRK, now beating 90% of investing public. With IQ of 90 you can copy Buffett trading – study done, you bought stock after him at the peak price of that day and hold until he sells it and sold it at the low price at the end of his hold you beat the S&P by 7% a year, now beating 95-99% of crowd.

o   To set up great investing operation, keys: #1 is simplicity, #2 is control.

o   If you have an IQ of 100+ you can set up an investment operation that simply buys what the great investors have bought based on their SEC required 13Fs outlining their holdings. He goes through them and starts reverse engineering them.

o   Example – Two guys at BRK manage portfolio. Scott and Ted, BRK has brand new position in Davita in Q4 2011 (runs dialysis centers). Ted had position for several years at previous fund.  Also bought more DirectTV. Plan: Buy at high point at end of Feb when 13F is released. Sell when they sell.

·Investment process - Mental model recap - Cloning. Look at top managers, investigate what they buy, buy what you understand. Almost all of his stock picks are lifted from someone else. “God bless the SEC for 13F filings”.

·Mental model – “secrets “– How many hours are there in a week? 168. How many hours is a typical FT job? 40 hours. How many hours left after? 128. People say to me they will quit their job and start a fund or business. I think this is dumb. Don’t quit, the job is paying your rent. Never start a business saying you’re going to quit and start the business. Don’t stop the cash flow.

·         You need to do the following:

o   Life tweaks – 1) Live really close to work (5 minutes to work, make 40 hours really 40 hours).

o   2) When you decide to start a business, stop working extra hours. You work just enough to not get fired. This is how he started his first business. Had 50 hours a week to run the business. More than enough time to get a business off the ground.

o   3) You do not need money to start a business. Venture capitalists are willing to fund your business, don’t even need a business plan or equity. They are Visa and Mastercard - Apply for every credit card possible, as you can declare bankruptcy. He applied for every credit card he could, got 20-25. Every time needed money for the business, maxed a card. $70K credit card debt + $30K retirement fund emptied (was 24). No obligations, single. “You get a free one shot early in your life when you have no assets. You can completely blow up once and not affect anything. “

o   4) Starbucks is your office – Don’t need an office.

o   Took ten months to get first client. Then good CF. In Jan 91 resigned. Boss said “we understand why you unplugged last year. When your business fails, come back, we’ll give you massive raise and a promotion.”

o   5) Start early. Per Munger, most great discoveries early in life because you’re not set in your ways. Problem with school system, pushed off. Buffett/Gates started in teen years. Time stamp: 42 minutes.

·Mental Model – Hare Krishna Flower – From Silgini book “Influence, The Psychology of Persuasion”.

o   Reciprocation Calibration Failure - LA – people in orange robes (hare krishnas) Would go up to the gates and look for people coming off in suits. They would attach themselves to these people, say “isn’t this a wonderful day” and give them a flower. Of course, guy has no interest in this, but the hare krishnas say “no obligation, please take the flower”. 1/10 business men take the flower to get rid of the guy. However, once you take the flower you are hosed as it signals reciprocation in your brain. You reach into your wallet and give him a few dollars. As soon as you get to the first trash can you throw the flower out, and he is right behind you, takes it out of the garbage and starts again. From caveman days – You kill a big beast and can’t eat it all, so you feed the whole tribe and store your extra meat in their stomachs. “Tribe, feel free to feast yourself, but when you bring down a big beast and I’m hungry, call me”. The problem in our brain circuitry with reciprocation is that our brains cannot calibrate the size of a favor. A small favor can lead to a big reciprication

·You request info from a fund and funds often send you a PDF. Pabrai Fund never does that. They always send a physical package plus a $50 pen. Better than the hare krishna flower. You send this to someone with a huge net worth, pen is too nice to throw out and it is too time consuming/difficult to send back (only 1 of 500 sent back). The rest take the flower and you need to reciprocate. Brain cannot calibrate. He sends a $50 pen, the recipient sends $1 million to invest (time stamp, 51 mins).

·Pabrai Fund – Basically a mailing outfit with a small investment office. Send 1,000-2,000 Pabrai books a year (professor says “you sent me the book”, built goodwill).

·Book suggestion – Priceless Model - Humans do not know the price of anything. We only know the price of something through comparison (e.g. comparing apartment rentals in an area). This can be taken advantage of.

·Bill Gates – Even if you are a monopoly, you have to ask for the order. Always ask for the order, people often forget to.

·Warren Buffett – Continuous Learning Machine, Your Brain and Body -> Propose to someone -> you can have any car, but you only can have that one car for the rest of your life. This will change how someone chooses a car, but also how they drive it. Taking car of your body and mind is the same. You want to continuously the value of the car, so you want to continuously ingest knowledge. Live as if you were to die tomorrow, learn as if you were to live forever.

Q&A (56min mark).

·Work/life balance, it’s important to you, how did this come about? – Father quote – “you come to the world naked, the leave the world naked, you have to fill in the middle”. In the US, you won’t starve to death, you won’t have survival issues. But people still worry about that extensively, but it’s not worth it. Should focus on things more relevant, like relationships, things that bring you happiness. Money is a small part of that equation, as is being a workaholic. Work should be more fun than fun. I’m on vacation every day. You want to set up your life like this.

·What are the patterns you have seen from your failed investments? – In 2008, read article on Checklist, and read Checklist Manifesto. Fields like aviation get close to zero failure rates through checklists. We do not learn anything from success. Only learn from failures. Big fan of Marcus Aurelius, stoicism, “failure is something that you should welcome and cherish because that is your true teacher”. When you go through loss of net worth, they get seared into your psyche.

o   I have started three businesses à Two took virtually no capital, and both created a lot of wealth. The Third, Digital Disruptors, took a lot of capital, $4.5MM, and it went to zero after a short period of time. I learned that when I start a business, don’t put money into it. They need brain power and other things. I would probably never ever go into a venture that needs money, and would find a way to get around the need of money.

o   2007 investment in Delta Financial (??), went bankrupt 18 months later. Mortgage company killed off in the housing crash. Lesson: Be very careful of leveraged financial institutions.

o   Our brain ignores common sense when overridden by greed. Charlie Munger said “you can never invest in a financial services company unless you understand the ethos and competence of management”. If you invest in an unethical company, they have a lot of leeway in how they recognize reserves, etc, or if they are stupid they can still be the same outcome. Need to be honest and smart (mentions Fairfax).

·Key lessons – #1 You can learn from others mistakes. I have studied Buffett’s Munger’s, etc. #2 Checklists help (Checklist Manifesto). #3 Work with others. Originally I would study things on my own and make a decision whether I would invest or not. Now another fund manager is main contact. Munger said he has always had someone. It is important to have someone that does not report to you, a peer, who can be totally honest with you with no downside. When I have conversations with this person, if he doesn’t buy but I do, I think about why he doesn’t buy à this is very valuable.

·How did you control your emotions in 2007-9 à The number one skill is patience. Munger said “you don’t make money when you buy or sell a stock, you make it when you wait”. Charlie Munger is the Chairman of the Daily Journal. From 1999 to 2009 they were generating $3-4MM of CF a year, and kept putting it in treasury bills. In one day in 2009 they took their entire pile of cash into two stocks, Wells Fargo and US bank. Does nothing in 9 years and in one day they go all in. Then no actions again to 2011.

·Father started 15 businesses, some scaled, would grow them but then they would blow up. Parents would spend when they had money and went bankrupt several times, scarred him. When graduated I wanted to get a job for life and save 15% (was stuck in this mindset). I have a rule: If on Monday morning I am not fired up, I will not go to work and I will hit the reset button. This has happened 3 times in my career. Haven’t regretted quitting jobs. The stability from the work comes with boredom. Father needled him to start a business, and I took the plunge but covered the downside, unlike his father.

·When should you start a business? – When you find a burning passion that will improve the world.

·Cloning - There is something in the human psyche that makes us want to do things the hard way. Finance is notorious for this. I have been talking for years about how you can clone but no one does it.

·How do you find the next great ideas/investors? – If you have 15-20 years of history that’s pretty good, and look at what they say. If you only buy ideas after other great investors have your error rate drops dramatically, like bumpers on the side of the car.

·Copying investors – Others might copy Warren Buffett’s purchase but they won’t hold it à The key is patience. The gene of cloning is quirky. Many are willing to clone but only partially. People will buy what Warren Buffett does but not completely, which is dumb. Cloning e.g. In-and-Out Burger. Anytime you go there there is a large line, only 10 or so items. It’s so simple but no one clones them. People copy but want to add their own twists (like serve drinks, large variety of toppings, etc), which defeats the point of copying. You need to copy everything.

·How did you convince people to invest in your funds? – Secret #2 – When I started the fund I had 8 investors, people who knew me well. I took them for dinner (gave them a flower) and told them “you were put on this earth for one reason, to sell the hell out of Pabrai Funds. You get no fees, nothing, but you will do it because you like me. In a year, went from 8 to 17 investors, bought them dinner again and told them again why they were on earth. Next year, 25 investors. The power of compounding. People don’t know what they are supposed to do, but if you tell them what they are supposed to do they will go do it.

·How do you distinguish between thinking you understand the business and actually understanding a business? – Charlie Munger says “to ask the question is to answer it”. If you are operating in your circle of confidence, you will not need to ask yourself if you understand the business. The moment you ask yourself if you understand the business, you do not understand the business. To ask the question is to answer it.

·The most important lessons – Simplicity, keep it simple, the best things in life are free, those that have passed have done great things and we do not need to start from scratch, be a learning machine.