Q: Hi. I'm from San Francisco, California. If I'm not mistaken, I read a comment of yours several years back in which you categorically rejected Chinese opportunities. If I remember correctly, you said they keep three sets of books: one for the government for tax purposes, one for running the business, and one for the owner's wife. But consider the macro situation that you alluded to before, and also, the fact that there's probably a serious chance that the Chinese currency can do better than the U.S. currency in the next three to five years, as well as the fact that there are some decent Chinese companies. For example China Mobile, I believe is very cash-producing, cash-rich, no-debt, and is trading at low multiples. Do you look at such opportunities? Do you consider them? That one looks like a great opportunity to me. And I was wondering if you are going to consider such opportunities outside of the U.S. market.
A: Yeah, that's a very good question. In fact, I said that Chinese businesses keep three sets of books, like you said: one for the government, one for the owner's wife, and one for the mistress. Those are the three sets of books. But yeah, the issue we run into with China is that first of all, quite a large number of businesses there are outside my circle of confidence. I have the same issue with India. If I were investing in India or in China, I would need to have a very solid handle on the ethos of the management and that's very hard. I can clearly tell you that if I'm investing in India, I want to be on the ground. And unlike the approach I take in the U.S., I'd want to kick the tires a lot, especially on the nature of management because Indian businesses tend to be over 50 percent family-controlled, so there's no such concept as leveraging pressure on businesses. And Chinese businesses are probably not that different. So there are many, many great Chinese businesses, there are many, many great Indian businesses. Both markets would be hard for me to invest in, sitting where I am right here.
Now having said that, we had some investments in India. Even Pabrai Funds used to have one investment in India -- Dr. Reddy's -- and we have one investment in China. So I did cross that hurdle. And in that situation, I had no questions about the ethos of management. I was able to skin that cat pretty well when we went down that path.
Q: I'm George Dumigan, from Connecticut. You've gone a bit philosophical on us, so I'd like to ask you a position question up front. In the '30s, in this country and in the UK and Europe, psychologists and psychiatrists studied sick people. Then along came Maslow, who studied healthy people. In the meltdown of this past year, not all fund managers did poorly. Paulson did extremely well. He made three billion dollars. Right now, one of his funds is 30 percent in gold, GDL, AU, etc. The IMF is selling for 102 tons of gold. The Chinese are thinking of, perhaps, buying all of it. I asked you two years ago in Chicago, as you know, if you would buy gold, and you gave the Buffett story. Now, since you started your funds, gold has gone from $250 to $1,000 -- a 400 percent increase. It does compare favorably with your results. So would you consider investing in gold?
A: Well, George, good question. And the answer is no.
Q: Why?
A: Well, the thing is, I have to stick with certain stances so that when they don't work, I can at least stand up here and explain why I did what I did. I've never been enamored with gold, though it does have some uses. It's used in jewelry and a few other products and certainly in India there's a massive demand for gold jewelry. But for the most part, it has value the way a Rembrandt has value. And so just like I wouldn't put your money in a Rembrandt, because it can be valued at whatever people say it's valued at, I wouldn't put your money in gold. But I do agree with your thesis about the currencies and assets. Actually, I should take that back. We have some investments in gold because some of the companies we own have gold mines, etc. Gold is just not a big portion of their total play.
Q: Mohnish, I have one little addition, if I may, to the question. it's not about gold, though Paulson has invested a tremendous amount in gold. Why not study the very most successful investors and find out exactly what they're doing, much as you've done with Buffett over the years? And from the answer before, you are in BYDDF in China.
A: Well, you said that; I didn't say that. I will say that, yeah, I have a lot of respect for Paulson he's a very smart guy. In fact, having listened to him give testimony and having read stuff about him, I have nothing but respect for him. But the thing is that we are all wired differently, and there are many things that Buffett does that I am probably incapable of doing or don't understand. Gold is an area where Pabrai Funds is unlikely to have a significant position now. I do believe that all the arguments about gold are even more effective when you talk about productive commodities. So I've moved quite a bit. If I look at the funds in 1999, 2000, 2001, 2002, I will probably see zero exposure in that space. We have very significant exposure now. I do believe that productive commodities have value, and some of them have significant scarcity long-term – especially if you have a low cost of production etc., you do well. Even in gold, the angle I would be most interested in pursuing would be to find the lowest cost gold producers. And if I could buy at cheap prices -- if gold is $1,000 and they're taking metal out of the ground at $100 or $150 -- I might be tempted to do something there. But I would say that generally, the nonproductive commodities, the Rembrandt-type commodities are not of interest.
Q: Hi, Mohnish - I'm from San Francisco. I figured since I'm a recovering "McKenzie consultant," I'll ask one two-part question. The first part is that I read somewhere that you're looking at LEAPS and covered calls. Are you still looking at options? What are your thoughts on that? The second part is about your new positioning strategy, which has you going for two, five, ten. How would you contrast that method with the Kelly criterion about trying to take big positions and getting the biggest gains from those?
A: Right, good question. So first of all, on the LEAPS and options and all that, the funds do nothing with any of that. I have played around with those things a little bit with my personal account, my personal money. My conclusions so far are that the funds are probably better off having nothing to do with any of those. The only thing I would say is that covered calls have some merit, but I probably need to do a lot more work and get a lot more data before I get anywhere close to the point of using them in the funds. What we would have to do if the funds wanted to get into options is to go through an amendment process with the investors. They'd have to approve it, and so on. So I would say we're either several years or infinitely far away from going down that path.
Your second question was about the Kelly criteria. So clearly, if you look at the Kelly criteria, you should work with very concentrated portfolios, and a couple of things come into play that have become front and center for me. First of all, I don't have permanent capital. I have temporary capital that can leave at the end of every year. And so if I make a Kelly bet, and it is in the middle of playing out, but then it goes down, and in the mean time, the capital leaves, I don't get a chance to complete the bet, right?
The second point is about concentration. In fact, I brought this issue up at a lunch I had with Charlie Munger a few months ago, and I started to tell Charlie how I had moved away from ten positions to more diversified 20 positions. So before I could even finish the sentence, he said to me, "You are thinking in a manner that is completely opposed to the way I think." He said, "You know that I'm not going to be giving you any type of support on this movement towards more diversity." And he went on to say that his own assets, obviously, are very concentrated at Berkshire and two or three other places. So I told him, "Charlie, the thing is that there's a difference between running your own money and running other people's money. When I'm running other people's money and I have very high volatility and the money leaves, I have no opportunity to ever make the money back for the investors. That's a permanent loss. In fact last year 15 percent of our assets left. We are up more than 100 percent since then, but we have no opportunity to make it up to those investors that left."
So I was surprised when Charlie changed his perspective and said, "You know, if you examine Berkshire Hathaway, and if you think of all the positions, like See's Candies or NetJets, as bets, by the time you get to the 20th bet, you'll be at about 80 percent of the assets. And so he said, effectively, "We, at Berkshire, are about that level of diversification." So he seemed to be okay with the notion of a less concentrated approach with other people's money or temporary capital.
This whole thought started with Seth Klarman. Seth gave a talk about a year ago in which he discussed how he typically makes three to five percent bets. And he said in about 26 or 27 years in business, they've only had about a dozen or so 10 percent bets -- about one every two years or so.
And I could clearly see that there have been many instances with Pabrai Funds in which we've made large bets, and we were wrong. When we were wrong, we did not use the Kelly odds properly. If you look at Sears, for example, the value was much higher. I exited at a loss, so whatever number I used in the Kelly formula was wrong. The Kelly formula is great, if you have your numbers down right and you have your probabilities down right. If the probabilities are wrong, then you're off. So that's why with the Kelly formula, you're better off always under-betting the Kelly, probably under-betting it quite substantially. So my take is that even with a ten-by-ten portfolio, we were under-betting the Kelly. With the 20-position portfolio, we will probably under-bet it even more and that's okay.Also check out:
A: Yeah, that's a very good question. In fact, I said that Chinese businesses keep three sets of books, like you said: one for the government, one for the owner's wife, and one for the mistress. Those are the three sets of books. But yeah, the issue we run into with China is that first of all, quite a large number of businesses there are outside my circle of confidence. I have the same issue with India. If I were investing in India or in China, I would need to have a very solid handle on the ethos of the management and that's very hard. I can clearly tell you that if I'm investing in India, I want to be on the ground. And unlike the approach I take in the U.S., I'd want to kick the tires a lot, especially on the nature of management because Indian businesses tend to be over 50 percent family-controlled, so there's no such concept as leveraging pressure on businesses. And Chinese businesses are probably not that different. So there are many, many great Chinese businesses, there are many, many great Indian businesses. Both markets would be hard for me to invest in, sitting where I am right here.
Now having said that, we had some investments in India. Even Pabrai Funds used to have one investment in India -- Dr. Reddy's -- and we have one investment in China. So I did cross that hurdle. And in that situation, I had no questions about the ethos of management. I was able to skin that cat pretty well when we went down that path.
Q: I'm George Dumigan, from Connecticut. You've gone a bit philosophical on us, so I'd like to ask you a position question up front. In the '30s, in this country and in the UK and Europe, psychologists and psychiatrists studied sick people. Then along came Maslow, who studied healthy people. In the meltdown of this past year, not all fund managers did poorly. Paulson did extremely well. He made three billion dollars. Right now, one of his funds is 30 percent in gold, GDL, AU, etc. The IMF is selling for 102 tons of gold. The Chinese are thinking of, perhaps, buying all of it. I asked you two years ago in Chicago, as you know, if you would buy gold, and you gave the Buffett story. Now, since you started your funds, gold has gone from $250 to $1,000 -- a 400 percent increase. It does compare favorably with your results. So would you consider investing in gold?
A: Well, George, good question. And the answer is no.
Q: Why?
A: Well, the thing is, I have to stick with certain stances so that when they don't work, I can at least stand up here and explain why I did what I did. I've never been enamored with gold, though it does have some uses. It's used in jewelry and a few other products and certainly in India there's a massive demand for gold jewelry. But for the most part, it has value the way a Rembrandt has value. And so just like I wouldn't put your money in a Rembrandt, because it can be valued at whatever people say it's valued at, I wouldn't put your money in gold. But I do agree with your thesis about the currencies and assets. Actually, I should take that back. We have some investments in gold because some of the companies we own have gold mines, etc. Gold is just not a big portion of their total play.
Q: Mohnish, I have one little addition, if I may, to the question. it's not about gold, though Paulson has invested a tremendous amount in gold. Why not study the very most successful investors and find out exactly what they're doing, much as you've done with Buffett over the years? And from the answer before, you are in BYDDF in China.
A: Well, you said that; I didn't say that. I will say that, yeah, I have a lot of respect for Paulson he's a very smart guy. In fact, having listened to him give testimony and having read stuff about him, I have nothing but respect for him. But the thing is that we are all wired differently, and there are many things that Buffett does that I am probably incapable of doing or don't understand. Gold is an area where Pabrai Funds is unlikely to have a significant position now. I do believe that all the arguments about gold are even more effective when you talk about productive commodities. So I've moved quite a bit. If I look at the funds in 1999, 2000, 2001, 2002, I will probably see zero exposure in that space. We have very significant exposure now. I do believe that productive commodities have value, and some of them have significant scarcity long-term – especially if you have a low cost of production etc., you do well. Even in gold, the angle I would be most interested in pursuing would be to find the lowest cost gold producers. And if I could buy at cheap prices -- if gold is $1,000 and they're taking metal out of the ground at $100 or $150 -- I might be tempted to do something there. But I would say that generally, the nonproductive commodities, the Rembrandt-type commodities are not of interest.
Q: Hi, Mohnish - I'm from San Francisco. I figured since I'm a recovering "McKenzie consultant," I'll ask one two-part question. The first part is that I read somewhere that you're looking at LEAPS and covered calls. Are you still looking at options? What are your thoughts on that? The second part is about your new positioning strategy, which has you going for two, five, ten. How would you contrast that method with the Kelly criterion about trying to take big positions and getting the biggest gains from those?
A: Right, good question. So first of all, on the LEAPS and options and all that, the funds do nothing with any of that. I have played around with those things a little bit with my personal account, my personal money. My conclusions so far are that the funds are probably better off having nothing to do with any of those. The only thing I would say is that covered calls have some merit, but I probably need to do a lot more work and get a lot more data before I get anywhere close to the point of using them in the funds. What we would have to do if the funds wanted to get into options is to go through an amendment process with the investors. They'd have to approve it, and so on. So I would say we're either several years or infinitely far away from going down that path.
Your second question was about the Kelly criteria. So clearly, if you look at the Kelly criteria, you should work with very concentrated portfolios, and a couple of things come into play that have become front and center for me. First of all, I don't have permanent capital. I have temporary capital that can leave at the end of every year. And so if I make a Kelly bet, and it is in the middle of playing out, but then it goes down, and in the mean time, the capital leaves, I don't get a chance to complete the bet, right?
The second point is about concentration. In fact, I brought this issue up at a lunch I had with Charlie Munger a few months ago, and I started to tell Charlie how I had moved away from ten positions to more diversified 20 positions. So before I could even finish the sentence, he said to me, "You are thinking in a manner that is completely opposed to the way I think." He said, "You know that I'm not going to be giving you any type of support on this movement towards more diversity." And he went on to say that his own assets, obviously, are very concentrated at Berkshire and two or three other places. So I told him, "Charlie, the thing is that there's a difference between running your own money and running other people's money. When I'm running other people's money and I have very high volatility and the money leaves, I have no opportunity to ever make the money back for the investors. That's a permanent loss. In fact last year 15 percent of our assets left. We are up more than 100 percent since then, but we have no opportunity to make it up to those investors that left."
So I was surprised when Charlie changed his perspective and said, "You know, if you examine Berkshire Hathaway, and if you think of all the positions, like See's Candies or NetJets, as bets, by the time you get to the 20th bet, you'll be at about 80 percent of the assets. And so he said, effectively, "We, at Berkshire, are about that level of diversification." So he seemed to be okay with the notion of a less concentrated approach with other people's money or temporary capital.
This whole thought started with Seth Klarman. Seth gave a talk about a year ago in which he discussed how he typically makes three to five percent bets. And he said in about 26 or 27 years in business, they've only had about a dozen or so 10 percent bets -- about one every two years or so.
And I could clearly see that there have been many instances with Pabrai Funds in which we've made large bets, and we were wrong. When we were wrong, we did not use the Kelly odds properly. If you look at Sears, for example, the value was much higher. I exited at a loss, so whatever number I used in the Kelly formula was wrong. The Kelly formula is great, if you have your numbers down right and you have your probabilities down right. If the probabilities are wrong, then you're off. So that's why with the Kelly formula, you're better off always under-betting the Kelly, probably under-betting it quite substantially. So my take is that even with a ten-by-ten portfolio, we were under-betting the Kelly. With the 20-position portfolio, we will probably under-bet it even more and that's okay.Also check out:
