Q: Rao, from Florida. So I guess the first ten years that Buffett ran the partnership, he did something kind of like you did when he was picking stocks. I felt that when he moved to Berkshire, he evolved. For instance, instead of making bets and changing them, he would hold on to an investment. Would you imagine that his method will change because of transaction costs as the fund gets bigger, or do you think it will cycle through once 50 cents becomes a dollar? Are you going to exit or ever hold on to investments long-term?
A: So actually, Buffett like someone said, is a learning machine, and he’s still learning today. There are a couple of things to keep in mind. One is we will never see another Warren Buffett; he’s a pretty unique individual. What we can try to do is learn from him and emulate certain aspects of him and we’ll become better as a result. But the part about Warren Buffett that gets overlooked quite a bit is Buffett the leader, because Buffett the investor is so good. Once you move into wholly-owned businesses, it is a completely different ballgame, where what matters a lot is your ability to lead people and your ability to hold on to managers.
In fact, the average Berkshire manager is worth several hundred million dollars. They don’t need to work. So how do you get people who are worth that much to not say "goodbye" or retire and move on to other things like starting a new business? Warren the leader is much harder to replicate or even try to emulate than the investing side of Warren. I have no illusions about that part being easy. At Pabrai Funds, at least, I don’t have any plans to ever get to a point of control positions, wholly-owned businesses, or any of that. The passive investing side is as far as I want to go, on that front. So that’s where we will take the funds. Plus, we tend to close to new money; we want to run a finite amount of money because we can manage that well. The Buffett-trajectory is a trajectory that most of us can't follow. And that history is still being written because he is still learning, and he’s still evolving as an investor. So we will just stick to the very basics of what he has taught us.
Q: I have a quick question on your checklist: Is it leading you to larger-cap businesses? Is it leading to wide-moat businesses, better diversified businesses, like Berkshire or Leucadia or something? And also, if the checklist leads to better liquidity in the fund itself, would you consider changing liquidity terms so that your investors have access to their capital more than once a year?
A: Well, you know some people got help because we were not so liquid. No, I’m pretty sure it’s not leading to bigger market caps because we’ve made plenty of investments that have tiny market caps. They were big enough for us. Historically, I would want to put 10 percent of our assets into a position. So if I'm managing $500 million and I want to put in 10 percent, I need to put $50 million in. And I’m sick and tired of all these filings I have to do. So if I want to stay under five percent, that means I need companies with market caps at $15 million, even over one billion dollars. And now, with the change, they can all be $500 million, right? It’s a lower number, so that makes it a little easier to make investments. I think, in general, I have learned to appreciate that if you have an undervalued asset, you’re much better off if the undervalued asset has a great manager overseeing it. So there are three pieces to look at. An undervalued asset is one piece, a great manager is a second piece, and a moat is a third piece. If you can get all three, then that’s utopia. You get a great manager, a great business that’s deeply undervalued, and of course, it’s hard to get there. I’m generally most interested in those businesses. I’ve learned that they can bail you out. If you’ve got great management, they can bail you out of situations that you can’t get out of otherwise.
But no, we haven't moved towards investing in conglomerates or anything like that. We are interested in some other aspects of investing that will allow us to get a great business, and get an undervalued business, and get great management. In fact, in the last year we've added several of those businesses, so it should be a nice ride. We’ll see.
Q: For the benefit of the audience, I will preface my question by saying that I’ve been a partner in
PIF3 for over five years, so I feel I’ve given the Pabrai process time to work. 2008 was an extraordinary year, in a number of ways, certainly in terms of the damage to the financial markets and the economy. And I don’t think it would be reasonable for us to expect the manager of long-only funds, like the ones you manage to escape unscathed. Nevertheless, even in the context of what happened, your performance was horrendous, from the peak to trough. Your funds lost about 70 percent. In all candor, that’s inexcusable. I listened very closely to your explanations on the adjustments you’re making to the position sizes; I listened closely to your explanation about the checklists; and I seriously question how that’s going to help, if we have another meltdown in the financial markets and the economy, which could very well happen. We’re under a very long-term deleveraging process, in terms of consumer credit.
And so here’s my question. You seem to focus exclusively on bottom-up, fundamental analysis, presumably under the assumption that’s going to help you withstand these types of environments. There doesn’t seem to be any emphasis on the larger macroeconomic picture. I’d like to know why because anyone who was paying attention to the credit bubble that was developing could have positioned himself accordingly. You claim there was no place to hide in 2008. There was what's called cash, but you seem to loathe to hold cash at any meaningful level. So I’d like you to speak, as specifically as you can, to what degree you’re willing to focus on the larger macroeconomic picture. If you’re not, why not?
A: Okay. Tom, those are great comments and good questions. Yes, that, by design, there are certain limitations in Pabrai Funds. First of all, we don’t go short, and we don’t use leverage. So an unlevered, long-only fund in 2008 would, probably have problems, excluding the cash position. I agree with you that if we were in a situation where we were, let’s say, 30 percent cash or 40 percent cash, our results would have been vastly better.
That as 2008 unfolded we investors, for the most part, were blindsided in the sense that we didn’t expect a lot of the stuff that took place in the fourth quarter. I can tell you, point blank, no matter what I studied, I wouldn’t have been able to forecast it. And most of our losses came in the fourth quarter. So we saw basic things going on, like money markets not being at par, big investment banks going under, Freddie and Fannie going under. There were a whole bunch of things going on that caused major dislocations. So I don’t think there’s anything I could have done. If I were a person fully focused on macro events, it would have been beyond my ability to forecast that Armageddon around the corner, to decide that I should do something radically different.
Now going forward, we will have some cushioning from a diverse set of holdings. It will not protect us in the event of major meltdowns like we saw. But I would be surprised if we see those types of meltdowns again. I agree with you that the market may flat line for a while. I agree with you the market may even drop from here for a while. The piece I didn’t talk about in this presentation is that I do have -- in fact, I’ve always had -- some appreciation, considerable appreciation for macro events. But what I always try
to do is to focus on events with high probability that I believe I can see clearly. There are many macro events with high probability that are hard to see, and some events with high probability that you can see.
Some of the things that I have focused on are what I would call macro events that seem high probability to me. And in fact, one of the changes Pabrai Funds has made is to place a greater emphasis on what I would call the "no-brainer" macro events. So one of the positional, directional changes I made towards the end of last year was a response to a couple of things that happened in the fourth quarter. We had major drops in equity prices, but the drops weren’t universal. The biggest drops took place in natural resource commodities. Mining, kind of hard-asset type companies -- those underwent the greatest drop.
In the environment that we are heading into, and the way the world is today, India, China and other emerging economies are growing at a faster clip than the larger developed countries are. You have the United States at an over $14 trillion economy, you have China at a five trillion dollar, six trillion dollar economy, India at about $1.2 trillion or so. This is not news, all of you know this. But the thing is that the pressure that that growth puts on limited natural resources that the earth’s crust can provide generally means that if you buy into those assets, buy into them at depressed prices, you’re going to be a beneficiary of that growth.
Also in this environment, we will at some point see inflation. We may see significant inflation. So again, if I own assets where the CAPEX is done in 2006 dollars and in 2012 we have significant inflation, then I’m probably a beneficiary of that. So the positioning change I made moved us more towards hard assets, more towards real assets, more towards assets which were a beneficiary of inflation. But I don’t have a view on when inflation will come in. And that’s not a high probability bet that one can make. I simply
expect it will come in at some point.
But I also feel that if it does not materialize, we won’t get hurt. So the bets are made no matter what. We’re not going to be fully dependent on just a single event. So the best I can say is that we are in better shape than we were. The combination of checklists, a little more emphasis on macro -- and I can, I would say, predict high probability macro events -- and more of the withholdings will help us.
On the cash front, there is some religion on moving towards higher cash provisions. It will take some time to reposition the portfolio and get everything else done, but as I speak to you right now, we’re generally a net seller. I have almost nothing on the radar that looks exciting to buy. So as far as I can see, we will probably do okay, but in an Armageddon situation, it’s hard to tell what will happen.
Q: I’m from San Diego, California. I believe you said in the past that you tend to want to wait about two years before you sell a stock to make sure your thesis is right. Has 2008 changed that thesis at all? Do you have stop limits in your head now, or have you made any sort of change to that philosophy?
A: Actually, I’ve never had a mandate to hold things for two years. That what I’ve said is that sometimes, it can take two or three years for a security to get to intrinsic value -- that can take a while. We’ve never done stop losses, and we probably will never do stop losses. In fact, I would say that stop losses might have hurt us -- to some extent would have protected us, but might have hurt us.
Just to give you an example, we’ve had plenty of positions in businesses which saw no impairment to their long-term natures as a result of the fourth quarter events. But I saw the value of those businesses drop more than 80 percent, 90 percent. And I’ve seen them in six months go up five, six, eight times in value on, really, not that much change. We haven’t had that much change happen to the businesses. They just went down a lot in value, and they came up a lot in value. So the two or three-year timeframe is one that I use as a guideline. I expect that it might take that long. And then, I can get to some type of reasonable rate of return. So we’ve never had stop losses, and I don’t think we’ll ever put stop losses in.
We are willing to be patient on the realization of intrinsic value. We are also very focused on taxes, so pretty much all of our gains come through in the long-term. Level 3 is an anomaly, from that point of view. But most of our gains are long-term, and we try to be tax-efficient on that front.
A: So actually, Buffett like someone said, is a learning machine, and he’s still learning today. There are a couple of things to keep in mind. One is we will never see another Warren Buffett; he’s a pretty unique individual. What we can try to do is learn from him and emulate certain aspects of him and we’ll become better as a result. But the part about Warren Buffett that gets overlooked quite a bit is Buffett the leader, because Buffett the investor is so good. Once you move into wholly-owned businesses, it is a completely different ballgame, where what matters a lot is your ability to lead people and your ability to hold on to managers.
In fact, the average Berkshire manager is worth several hundred million dollars. They don’t need to work. So how do you get people who are worth that much to not say "goodbye" or retire and move on to other things like starting a new business? Warren the leader is much harder to replicate or even try to emulate than the investing side of Warren. I have no illusions about that part being easy. At Pabrai Funds, at least, I don’t have any plans to ever get to a point of control positions, wholly-owned businesses, or any of that. The passive investing side is as far as I want to go, on that front. So that’s where we will take the funds. Plus, we tend to close to new money; we want to run a finite amount of money because we can manage that well. The Buffett-trajectory is a trajectory that most of us can't follow. And that history is still being written because he is still learning, and he’s still evolving as an investor. So we will just stick to the very basics of what he has taught us.
Q: I have a quick question on your checklist: Is it leading you to larger-cap businesses? Is it leading to wide-moat businesses, better diversified businesses, like Berkshire or Leucadia or something? And also, if the checklist leads to better liquidity in the fund itself, would you consider changing liquidity terms so that your investors have access to their capital more than once a year?
A: Well, you know some people got help because we were not so liquid. No, I’m pretty sure it’s not leading to bigger market caps because we’ve made plenty of investments that have tiny market caps. They were big enough for us. Historically, I would want to put 10 percent of our assets into a position. So if I'm managing $500 million and I want to put in 10 percent, I need to put $50 million in. And I’m sick and tired of all these filings I have to do. So if I want to stay under five percent, that means I need companies with market caps at $15 million, even over one billion dollars. And now, with the change, they can all be $500 million, right? It’s a lower number, so that makes it a little easier to make investments. I think, in general, I have learned to appreciate that if you have an undervalued asset, you’re much better off if the undervalued asset has a great manager overseeing it. So there are three pieces to look at. An undervalued asset is one piece, a great manager is a second piece, and a moat is a third piece. If you can get all three, then that’s utopia. You get a great manager, a great business that’s deeply undervalued, and of course, it’s hard to get there. I’m generally most interested in those businesses. I’ve learned that they can bail you out. If you’ve got great management, they can bail you out of situations that you can’t get out of otherwise.
But no, we haven't moved towards investing in conglomerates or anything like that. We are interested in some other aspects of investing that will allow us to get a great business, and get an undervalued business, and get great management. In fact, in the last year we've added several of those businesses, so it should be a nice ride. We’ll see.
Q: For the benefit of the audience, I will preface my question by saying that I’ve been a partner in
PIF3 for over five years, so I feel I’ve given the Pabrai process time to work. 2008 was an extraordinary year, in a number of ways, certainly in terms of the damage to the financial markets and the economy. And I don’t think it would be reasonable for us to expect the manager of long-only funds, like the ones you manage to escape unscathed. Nevertheless, even in the context of what happened, your performance was horrendous, from the peak to trough. Your funds lost about 70 percent. In all candor, that’s inexcusable. I listened very closely to your explanations on the adjustments you’re making to the position sizes; I listened closely to your explanation about the checklists; and I seriously question how that’s going to help, if we have another meltdown in the financial markets and the economy, which could very well happen. We’re under a very long-term deleveraging process, in terms of consumer credit.
And so here’s my question. You seem to focus exclusively on bottom-up, fundamental analysis, presumably under the assumption that’s going to help you withstand these types of environments. There doesn’t seem to be any emphasis on the larger macroeconomic picture. I’d like to know why because anyone who was paying attention to the credit bubble that was developing could have positioned himself accordingly. You claim there was no place to hide in 2008. There was what's called cash, but you seem to loathe to hold cash at any meaningful level. So I’d like you to speak, as specifically as you can, to what degree you’re willing to focus on the larger macroeconomic picture. If you’re not, why not?
A: Okay. Tom, those are great comments and good questions. Yes, that, by design, there are certain limitations in Pabrai Funds. First of all, we don’t go short, and we don’t use leverage. So an unlevered, long-only fund in 2008 would, probably have problems, excluding the cash position. I agree with you that if we were in a situation where we were, let’s say, 30 percent cash or 40 percent cash, our results would have been vastly better.
That as 2008 unfolded we investors, for the most part, were blindsided in the sense that we didn’t expect a lot of the stuff that took place in the fourth quarter. I can tell you, point blank, no matter what I studied, I wouldn’t have been able to forecast it. And most of our losses came in the fourth quarter. So we saw basic things going on, like money markets not being at par, big investment banks going under, Freddie and Fannie going under. There were a whole bunch of things going on that caused major dislocations. So I don’t think there’s anything I could have done. If I were a person fully focused on macro events, it would have been beyond my ability to forecast that Armageddon around the corner, to decide that I should do something radically different.
Now going forward, we will have some cushioning from a diverse set of holdings. It will not protect us in the event of major meltdowns like we saw. But I would be surprised if we see those types of meltdowns again. I agree with you that the market may flat line for a while. I agree with you the market may even drop from here for a while. The piece I didn’t talk about in this presentation is that I do have -- in fact, I’ve always had -- some appreciation, considerable appreciation for macro events. But what I always try
to do is to focus on events with high probability that I believe I can see clearly. There are many macro events with high probability that are hard to see, and some events with high probability that you can see.
Some of the things that I have focused on are what I would call macro events that seem high probability to me. And in fact, one of the changes Pabrai Funds has made is to place a greater emphasis on what I would call the "no-brainer" macro events. So one of the positional, directional changes I made towards the end of last year was a response to a couple of things that happened in the fourth quarter. We had major drops in equity prices, but the drops weren’t universal. The biggest drops took place in natural resource commodities. Mining, kind of hard-asset type companies -- those underwent the greatest drop.
In the environment that we are heading into, and the way the world is today, India, China and other emerging economies are growing at a faster clip than the larger developed countries are. You have the United States at an over $14 trillion economy, you have China at a five trillion dollar, six trillion dollar economy, India at about $1.2 trillion or so. This is not news, all of you know this. But the thing is that the pressure that that growth puts on limited natural resources that the earth’s crust can provide generally means that if you buy into those assets, buy into them at depressed prices, you’re going to be a beneficiary of that growth.
Also in this environment, we will at some point see inflation. We may see significant inflation. So again, if I own assets where the CAPEX is done in 2006 dollars and in 2012 we have significant inflation, then I’m probably a beneficiary of that. So the positioning change I made moved us more towards hard assets, more towards real assets, more towards assets which were a beneficiary of inflation. But I don’t have a view on when inflation will come in. And that’s not a high probability bet that one can make. I simply
expect it will come in at some point.
But I also feel that if it does not materialize, we won’t get hurt. So the bets are made no matter what. We’re not going to be fully dependent on just a single event. So the best I can say is that we are in better shape than we were. The combination of checklists, a little more emphasis on macro -- and I can, I would say, predict high probability macro events -- and more of the withholdings will help us.
On the cash front, there is some religion on moving towards higher cash provisions. It will take some time to reposition the portfolio and get everything else done, but as I speak to you right now, we’re generally a net seller. I have almost nothing on the radar that looks exciting to buy. So as far as I can see, we will probably do okay, but in an Armageddon situation, it’s hard to tell what will happen.
Q: I’m from San Diego, California. I believe you said in the past that you tend to want to wait about two years before you sell a stock to make sure your thesis is right. Has 2008 changed that thesis at all? Do you have stop limits in your head now, or have you made any sort of change to that philosophy?
A: Actually, I’ve never had a mandate to hold things for two years. That what I’ve said is that sometimes, it can take two or three years for a security to get to intrinsic value -- that can take a while. We’ve never done stop losses, and we probably will never do stop losses. In fact, I would say that stop losses might have hurt us -- to some extent would have protected us, but might have hurt us.
Just to give you an example, we’ve had plenty of positions in businesses which saw no impairment to their long-term natures as a result of the fourth quarter events. But I saw the value of those businesses drop more than 80 percent, 90 percent. And I’ve seen them in six months go up five, six, eight times in value on, really, not that much change. We haven’t had that much change happen to the businesses. They just went down a lot in value, and they came up a lot in value. So the two or three-year timeframe is one that I use as a guideline. I expect that it might take that long. And then, I can get to some type of reasonable rate of return. So we’ve never had stop losses, and I don’t think we’ll ever put stop losses in.
We are willing to be patient on the realization of intrinsic value. We are also very focused on taxes, so pretty much all of our gains come through in the long-term. Level 3 is an anomaly, from that point of view. But most of our gains are long-term, and we try to be tax-efficient on that front.
