Q: The challenge as you increase the number of positions is that you end up getting closer and closer to the market. So during time periods when there may be a lot of opportunities, let's say Q4 or Q1, taking a large number of positions doesn't affect your performance. But then as you go into a more normal market where the number of great positions decrease's, and the further you move away from your Kelly criterion, you could see an effect on your performance relative to the index.
A: Yeah, that's a very valid point. In fact, we've seen that happen. We find lots of opportunity in the fourth quarter, and we find very few opportunities as the market normalizes. And as to Tom's point here, we are probably going to end up with more cash, so he'll be happier. But you're absolutely right. I will probably end up withholding more cash for longer periods. And so I can see our investing move in a manner characterized by, I would say, long periods of inactivity, then bursts of a lot of activity, then again, long periods of inactivity, and significant cash flow holdings. And I am okay with that.
Q: Good evening. Mannish, you talked about the checklist that you've come up with and how you are applying it to investments you're making today and how you will apply it going forward. Do you have a sense, in terms of number of industries, of a minimum that you should have in your portfolio, or a percentage of the portfolio that's in international firms? Would anything like that be on your checklist? And without revealing your secret sauce, maybe you could share one or two or three of those points with us?
A: Yeah. So obviously, we are not going to put everything into the same industry. The checklist doesn't need much time. I would say that if I run through the checklist on a given position, I typically do it after I've done the work and the analysis.
The first go around takes no less than 20 minutes because I'm just marking down all the red flags.Those red flags point to several questions I don't have the answer to. So I have to go find the answers, which is great. I go do some more work and I come back. Now I might have only four red flags, just a couple of things on the checklist. Then I'll get to the industries.There is pretty much no position and no stock I can come up with that will go through the checklist with no issues.
So it's very different from the situation in the ICU or for the FAA pilots. Pilots cannot takeoff if they have a checklist problem. But in investing,you're going to run into issues because, for example, I have maybe 10 questions on different facets of leverage. There are probably another half a dozen questions on management, various aspects of management, like ownership, ethos, all kinds of different things that have come to either burn me or burn others in the past. I would love to own businesses in which managements have large stakes. That's one of the checklist questions. Does management have a large stake? Well, are you always going to exclude a business in which management doesn't have a large stake? No, you're not going to exclude a business just for that reason, if everything else is fine. But for any portfolio, you want to make sure that all your businesses are not businesses in which management has very low stakes because you kind of get stuck investing in one particular manner.
You also don't want businesses that are all leveraged. So if you say, "I will never invest in a business that uses leverage," well, that wipes out probably 70 percent, 80 percent of the market, and you can't do that. So you have to make trade-offs, and the main thing the checklist does is put the trade-off in front of you. It clearly tells you, "Look, out of the 60 items, here are the six items that are an issue."Maybe there's not much ownership stake, or this is a company that could have union issues in the future, even though there are no union issues today. So those types of things you can see up front with the checklist. So that's the thing, now.The second point about the industries is a natural thing. If I have three banks in the portfolio, I'm probably not going to put in three more. I'm always looking at the diversification of the portfolio, and the checklist has questions on that. But even before the checklist, from the moment I run into a business, the first thing I look at is how it looks in comparison to the rest of the companies. And then we can take it from there.
Q: Ray Faltinski from San Diego. I've got a few quick questions, so I'll just do them one at a time - any purchases in the third quarter?
A: Oh, we don't disclose that.
Q: Not what you purchased; did you make any?
A: There was one we were buying at the edge of the second, beginning of the third that moved up.
Q: Current cash position.
A: We don't disclose that.
Q: You don't say that. Okay, I'm new here.
A: That's okay.
Q: I got lucky. I invested April 1st, so that was a good day. Let me ask you something,notwithstanding the great year you've had. Compared to Paulson, by the way, you're worth about five times what he is this year. He's up about 19 percent, so congratulations on that. During that fourth quarter, I'm curious what was going through your mind. Was your confidence shaken? I mean, it was a pretty tough time, what was going through your mind, and how did you deal with that? And if your confidence was shaken, has the great year you've had brought it back?
A: No, actually, I didn't have any confidence issues. I was just focused on two factors. One was that I was watching the redemption numbers closely because we wanted to make sure that we could do a systematic exit, whatever happened. And it was very hard for me to know the results until November 1st, our redemption deadline, because things were still happening in October. The first thing I focused on was where exactly we were going to end up on that front so I'd know our cash needs.The second factor while all of this was going on was that the opportunity set was incredible. It was one of the largest sets of opportunities I've ever seen. And so the main thing I was doing was a lot of reading; I dropped pretty much everything else.
There was no general reading up; I was just buried in reading annual reports, 10Ks, 10Qs, calls, and so on. It was very exciting to look at what these assets were trading at. I was, I would say, very excited about that.But then the other side was just trying to figure out, "Okay, I know my assets have shrunk; I know a bunch of our asset base is going to leave. Now we have the rest of it left, but we have a huge opportunity set, so do we swap out? And what do we swap out?" Those are the kinds of questions I was thinking through. But I didn't have any issues with confidence around any of that. I thought we would do fine. We didn't have any leverage, we didn't have any margin calls, we didn't have any kind of screens like that. We had many businesses that had dropped a lot in price, though I didn't think the drop was justified. But we said, "Okay, we can wait it out." So that's what took place, at that point.
