Q: I'm from Huntington Beach, California. How would you react to or interact with a company that presented itself with a positive history that encouraged you to invest with it, but that then, in a short while -- all of a sudden and overnight -- it dissolved out of the picture? How would you trust other companies that might present themselves in the same way when you're not sure if they are going to dissolve or not? How would you handle a company like Novistar for example?
A: Okay, good question. So first of all, we don't let companies pitch to us. I don't typically have interactions or meetings with management of companies. But we certainly get their pitches by reading their materials, by reading their annual reports, and maybe their conference calls, and 10Ks, and 10Qs, and so on. So we definitely could be sold a story that could happen. So what you're talking about is a company that, in the past, did well and then liquidated after that. Well two questions come to mind. One is, were the past financials fraudulent? Was there fraud in the case of Novistar? I'm not familiar with Novistar. Pardon?
Q: [Inaudible]
A: So was there fraud or they just went under?
Q: [Inaudible]
A: Okay. So I would say that most times, when investors lose money, it's because of their own mistakes. It is not typically because someone defrauded them. Now when there's a loss, often the headlines will suggest that there was some Bernie Madoff type situation and so on. But those situations I believe, are anomalies and rare. Again, most times when investors don't do well, it's because of their own mistakes. No one did anything illegal. the biggest protection you have against fraud is to educate yourself as much as you can about the business to make the best judgment you can about the future prospects of that business. That's the best you can do. From what he's explaining, it sounds like Novistar ran into headwinds -- probably not too dissimilar to some of the headwinds we ran into -- with what they were trying to do.
Q: I'm curious what you think about the U.S. economy today. Many argue that we've never had so much debate about where we are and whether we're starting recovery and what that recovery is going to look like, what the new normal is going to be. So I'm curious about your view on that. And then, what factors do you look at in the economy, whether it be housing or unemployment, as you make your decisions on investments?
A: Yeah, that's a good question. So again, the macro stuff is kind of hard to nail. I try to stick with what is a conservative position, so that if we are wrong, we are not hurt too badly. My take is that it's going to take a while to get back on track. And one of the problems we have is with some of the reported numbers.
Let's take, for example, unemployment: Unemployment numbers understate, quite significantly, the actual number of people that are unemployed. In California, sources say unemployment is at 10 or 11 percent, though the real number is probably 16 or 17 percent because they don't count discouraged workers, they don't count people who went from full-time to part-time, they don't count college students who have never had a job, but are looking for a job. There's a whole bunch of people who aren't counted in those statistics. And they fall off. After looking actively for a job for a while, you get discouraged. So there are a number of reasons why the numbers are understated. My general take is that it will take a while to get back on track. I don't know what a while is, but it could be several years. We also face basic issues we've had for a long time: the dual deficits, the trade deficit, and the current account deficit. And those show no sign of abating. I would say that the current account deficit is especially bothersome. Take the example of a family: If a family makes $100,000 a year, but they borrow the money, and they spend $150,000 or $200,000 a year, at some point the interest payments exceed the ability to service the interest.
And of course, we have a family here, the U.S. government, which has a printing press. So they can always make payments by turning on the press. Until the longer-term issues get solved, we've got that overhang sitting on top of us. Consider that there are only two companies to invest in -- let's say there's Costco and let's say there's Tiffany's. Given the situation we are in, I would put it all in Costco, because that's essential spending. Everything else, like Tiffany's, is discretionary spending.
So in general, with the situation of the economy the way it is today, my direction is to look at essentials that people cannot avoid -- what they have to buy and what they have to consume -- and look at companies which have defensible moats, etc., in that space. I also want to see if I can leverage the growth in China or the growth in India, the growth in other places. And many times, you can leverage that growth without investing in those companies. If you buy a low-cost natural resource mine, you can benefit from that.
So the approach has been to assume that we will tread water for a while in the U.S., focus on the essentials, and focus on things that people have to go after and on what they'll do okay with. So that's where I'm going with on that front.
Q: You were an entrepreneur before you got into this business. What kind of a process did you go through from selling your business to starting Pabrai Funds? And if you were an entrepreneur who, recently having cashed out, was sitting on, say, two or three million dollars, and you could make good returns on your own investment, what would be your reasons for and against starting a fund?
A: Actually, I did not start Pabrai Funds as a way to make money or even to make investing a profession. Pabrai Funds started as a hobby. I had a few friends to whom I used to give stock tips. I used to find these companies that were under-valued, and I'd tell them my friends should invest in them. Those investments tended to do well. But it was very random in that they might buy something and we might not meet for a while; then I would sell, but they'd still be holding -- that sort of cycle. So they approached me and said, "Can you make this more systematic? Can we give you some capital and have you manage it?"
So when I set up Pabrai Funds, I saw it as a vehicle for about eight of us and our one million dollars -- just to invest that money on an ad hoc basis, just to get more structure in place. There was no plan to make it into what it is today. I still had my business when Pabrai Funds started, so this was a part-time venture. Then I sold the business and my time freed up. At the time, the funds, I think, had two or three million dollars in them. So I looked back at the Buffett partnership and I said, "You know, he started investing full-time with $100,000, and that, in today's dollars, is $700,000." He was running less money than I was, at the start up. So I thought that I should, perhaps, look at doing it full time because I was enjoying the different nuances of running the fund. So that's why I decided to do that.
In your situation, I would say that the number one thing you have to ask yourself is, "What are you passionate about? And are you good at it?" So if you've done some investing for yourself for a few years, and you've done well in it and you want to take it further, the next step is to ask friends, family, and fools if they will give you money to invest, and then take it from there.
Q: After that initial two or three million dollars, how did you raise the assets? I'm also an entrepreneur. I started a software company about 10 years back. I was so much invested in Buffett principles and those kinds of things that I started investing my own money, did well, and became more confident. Last November, I took $100,000 and I started a fund, which is now at $740,000. So it's up 600 percent over nine months. I'm looking for investors, but I don't know where to find them. So what advice would you give to me? How did you raise the assets after the family and friends?
A: Well, there's a bunch of people who just heard your story, so they might approach you during cocktails or dinner, and that might get you going. But the rules about raising capital, especially in hedge fund structures, do not allow you to advertise or solicit. Investors have to come to you, and the best way to make that happen is, first, to get people who know you very well to give you some money to invest. If you can't do that, then you ought to call it quits because if people who know you well and have known you for a long time don't want to give you money, then there's an issue. After you have their money, then they become your salesmen. You try to impress upon them why they were put on this good earth, and what their mission in life is, and take it from there. And if you deliver 600 percent for them, they'll do all kinds of things for you. So that's the approach I would take.
Q: [Inaudible]
A: I would say most of the assets have come in over the Trans Am with people referring people. Once we gained some critical mass, I noticed the one unusual thing about the fund management business and about the value investing business is that there are very, very few -- I was surprised how few -- good investors there are. As John Bogle says, about one in 200 managers does more than three percent better than the index. So in general, if you are a money manager who, over some period of time, performs better than the indices, then the world will, generally, find you and come to you just because most money is not managed that well.
A: Okay, good question. So first of all, we don't let companies pitch to us. I don't typically have interactions or meetings with management of companies. But we certainly get their pitches by reading their materials, by reading their annual reports, and maybe their conference calls, and 10Ks, and 10Qs, and so on. So we definitely could be sold a story that could happen. So what you're talking about is a company that, in the past, did well and then liquidated after that. Well two questions come to mind. One is, were the past financials fraudulent? Was there fraud in the case of Novistar? I'm not familiar with Novistar. Pardon?
Q: [Inaudible]
A: So was there fraud or they just went under?
Q: [Inaudible]
A: Okay. So I would say that most times, when investors lose money, it's because of their own mistakes. It is not typically because someone defrauded them. Now when there's a loss, often the headlines will suggest that there was some Bernie Madoff type situation and so on. But those situations I believe, are anomalies and rare. Again, most times when investors don't do well, it's because of their own mistakes. No one did anything illegal. the biggest protection you have against fraud is to educate yourself as much as you can about the business to make the best judgment you can about the future prospects of that business. That's the best you can do. From what he's explaining, it sounds like Novistar ran into headwinds -- probably not too dissimilar to some of the headwinds we ran into -- with what they were trying to do.
Q: I'm curious what you think about the U.S. economy today. Many argue that we've never had so much debate about where we are and whether we're starting recovery and what that recovery is going to look like, what the new normal is going to be. So I'm curious about your view on that. And then, what factors do you look at in the economy, whether it be housing or unemployment, as you make your decisions on investments?
A: Yeah, that's a good question. So again, the macro stuff is kind of hard to nail. I try to stick with what is a conservative position, so that if we are wrong, we are not hurt too badly. My take is that it's going to take a while to get back on track. And one of the problems we have is with some of the reported numbers.
Let's take, for example, unemployment: Unemployment numbers understate, quite significantly, the actual number of people that are unemployed. In California, sources say unemployment is at 10 or 11 percent, though the real number is probably 16 or 17 percent because they don't count discouraged workers, they don't count people who went from full-time to part-time, they don't count college students who have never had a job, but are looking for a job. There's a whole bunch of people who aren't counted in those statistics. And they fall off. After looking actively for a job for a while, you get discouraged. So there are a number of reasons why the numbers are understated. My general take is that it will take a while to get back on track. I don't know what a while is, but it could be several years. We also face basic issues we've had for a long time: the dual deficits, the trade deficit, and the current account deficit. And those show no sign of abating. I would say that the current account deficit is especially bothersome. Take the example of a family: If a family makes $100,000 a year, but they borrow the money, and they spend $150,000 or $200,000 a year, at some point the interest payments exceed the ability to service the interest.
And of course, we have a family here, the U.S. government, which has a printing press. So they can always make payments by turning on the press. Until the longer-term issues get solved, we've got that overhang sitting on top of us. Consider that there are only two companies to invest in -- let's say there's Costco and let's say there's Tiffany's. Given the situation we are in, I would put it all in Costco, because that's essential spending. Everything else, like Tiffany's, is discretionary spending.
So in general, with the situation of the economy the way it is today, my direction is to look at essentials that people cannot avoid -- what they have to buy and what they have to consume -- and look at companies which have defensible moats, etc., in that space. I also want to see if I can leverage the growth in China or the growth in India, the growth in other places. And many times, you can leverage that growth without investing in those companies. If you buy a low-cost natural resource mine, you can benefit from that.
So the approach has been to assume that we will tread water for a while in the U.S., focus on the essentials, and focus on things that people have to go after and on what they'll do okay with. So that's where I'm going with on that front.
Q: You were an entrepreneur before you got into this business. What kind of a process did you go through from selling your business to starting Pabrai Funds? And if you were an entrepreneur who, recently having cashed out, was sitting on, say, two or three million dollars, and you could make good returns on your own investment, what would be your reasons for and against starting a fund?
A: Actually, I did not start Pabrai Funds as a way to make money or even to make investing a profession. Pabrai Funds started as a hobby. I had a few friends to whom I used to give stock tips. I used to find these companies that were under-valued, and I'd tell them my friends should invest in them. Those investments tended to do well. But it was very random in that they might buy something and we might not meet for a while; then I would sell, but they'd still be holding -- that sort of cycle. So they approached me and said, "Can you make this more systematic? Can we give you some capital and have you manage it?"
So when I set up Pabrai Funds, I saw it as a vehicle for about eight of us and our one million dollars -- just to invest that money on an ad hoc basis, just to get more structure in place. There was no plan to make it into what it is today. I still had my business when Pabrai Funds started, so this was a part-time venture. Then I sold the business and my time freed up. At the time, the funds, I think, had two or three million dollars in them. So I looked back at the Buffett partnership and I said, "You know, he started investing full-time with $100,000, and that, in today's dollars, is $700,000." He was running less money than I was, at the start up. So I thought that I should, perhaps, look at doing it full time because I was enjoying the different nuances of running the fund. So that's why I decided to do that.
In your situation, I would say that the number one thing you have to ask yourself is, "What are you passionate about? And are you good at it?" So if you've done some investing for yourself for a few years, and you've done well in it and you want to take it further, the next step is to ask friends, family, and fools if they will give you money to invest, and then take it from there.
Q: After that initial two or three million dollars, how did you raise the assets? I'm also an entrepreneur. I started a software company about 10 years back. I was so much invested in Buffett principles and those kinds of things that I started investing my own money, did well, and became more confident. Last November, I took $100,000 and I started a fund, which is now at $740,000. So it's up 600 percent over nine months. I'm looking for investors, but I don't know where to find them. So what advice would you give to me? How did you raise the assets after the family and friends?
A: Well, there's a bunch of people who just heard your story, so they might approach you during cocktails or dinner, and that might get you going. But the rules about raising capital, especially in hedge fund structures, do not allow you to advertise or solicit. Investors have to come to you, and the best way to make that happen is, first, to get people who know you very well to give you some money to invest. If you can't do that, then you ought to call it quits because if people who know you well and have known you for a long time don't want to give you money, then there's an issue. After you have their money, then they become your salesmen. You try to impress upon them why they were put on this good earth, and what their mission in life is, and take it from there. And if you deliver 600 percent for them, they'll do all kinds of things for you. So that's the approach I would take.
Q: [Inaudible]
A: I would say most of the assets have come in over the Trans Am with people referring people. Once we gained some critical mass, I noticed the one unusual thing about the fund management business and about the value investing business is that there are very, very few -- I was surprised how few -- good investors there are. As John Bogle says, about one in 200 managers does more than three percent better than the index. So in general, if you are a money manager who, over some period of time, performs better than the indices, then the world will, generally, find you and come to you just because most money is not managed that well.
