Mohnish Pabrai Learned Well From the Masters and Became One Himself

This hedge fund manager has done an outstanding job of growing his client's capital

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Oct 23, 2017
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“Value investing is pretty straightforward you try to get $1 worth of assets for much less than $1. There is no way to improve on that basic truth. It's timeless.” –Â Mohnish Pabrai

Because Mohnish Pabrai (Trades, Portfolio) runs closed funds, the exact level of returns are not available but every partial assessment indicates he performs well above the crowd. For example, a 2013 report says Pabrai delivered a cumulative 517% net gain to investors between 2000 and 2013 while the Standard & Poor's 500 Index gained 43% over the same period. And a report for 2017, to date, shows a return well into the mid-double digits.

Pabrai has done this by following many gurus, but Warren Buffett (Trades, Portfolio) was his original guiding star. And he has learned well from the master, in particular by studying Buffett’s successes and failures.

And, like Buffett, he does not invest, he buys businesses.

Who is Pabrai?

The guru was born in 1964 and earned a B.S. in computer engineering in 1986. That was followed by a five-year stint at Tellabs (an optical networking company).

According to the Form ADV for Pabrai Investment Funds, Pabrai started TransTech Inc., an IT consulting and systems integration firm. He launched it out of his home with an initial investment of $100,000 in personal savings and credit card debt. By the time he sold the company in 2000, he had grown it into an Inc. 500 company with revenues of more than $20 million per year, despite taking in no outside investment.

He started Pabrai Investment Funds in 1999 with $1 million in assets under management, which had grown to $664.4 million this year, according to the latest Form ADV filing on May 25.

Pabrai is also the founder and chair of the Dakshana Foundation, which helps economically and socially disadvantaged children around the world.

He is the author of two books, “The Dhandho Investor: The Low-Risk Value Method to High Returns” (2009) and “Mosaic: Perspectives on Investing (2004). Wikipedia notes that the latter book sees Pabrai distilling the Warren Buffett (Trades, Portfolio) method down to a few points. And that he and Guy Spier bid $650,100 for a charity lunch with Buffett in 2007.

Value investors often speak of investing as becoming an owner of a business; Pabrai went beyond that standard, by starting, growing and selling his own tech company before becoming an investor. His experience also suggests he has intensive, in-depth knowledge of technology and an appreciation of its potential.

Pabrai’s companies

The guru founded, and operates through, three major firms based in Irvine, California:

  • Dalal Street LLC: Formed in 2005, it does business as Pabrai Investment Funds and provides investment management services to limited partnerships or companies (private pooled investment vehicles).
  • Dhandho Funds: According to the firm’s website, it “applies core value investing principles to offer unique investment options that are smarter for the long-term investor.” In the Form ADV Part 2A it says the firm seeks to make friendly investments in high-quality businesses with high-quality managements in place.
  • Pabrai Investment Funds: operates three mutual funds (closed).

From Pabrai Funds, manager Dalal Street receives 25% of the increase in a client's net assets over 6% annually (subject to a highwater mark). In addition, clients pay up to 1% of the capital contributions for Dhandho Holdings, but there are no management expenses.

As the firm has grown, it has layered on Dalal and Dhandho, the first to advise on the Pabrai funds, and the second to seek out and make “unique” investments for fund holders and other clients. And like many hedge funds, Pabrai’s receive little or no compensation unless they meet a minimum, threshold return (but have the potential to profit handsomely if they do).

Pabrai’s investment strategies

First, to understand Pabrai is to understand Buffett and his partner, Charlie Munger (Trades, Portfolio).

In the Forbes’ transcript of an investing podcast, Pabrai said he accidentally discovered Buffett while reading a book by Peter Lynch and (directly or indirectly) discovered his life’s true calling (unless otherwise noted, references in this section originate with the Forbes article).

As someone with a serial entrepreneur for a father, and an entrepreneur himself, Pabrai quickly realized what Buffett was saying when he talked about owning a business, rather than stocks. He believes being an entrepreneur makes him a better business owner, and being a business owner makes him a better investor. He also agrees with Buffett about analysts –Â don’t hire them; Pabrai says if you hire analysts you will not understand an investing proposition as well as if you did it all yourself.

Pabrai also took from Buffett and Munger the idea of putting a CEO at the center of a business in which he invests heavily. He does not attempt to steer the CEO in any way; he simply picks a person who he believes can bring knowledge and wisdom to the task of running the company.

Like his idols, Pabrai puts investing and business ownership in different boxes. On the investing side, he’s not concerned with the economy or even market cycles; instead he thinks as a business owner that those external issues matter less than what the business can generate in years ahead. He points to Buffett’s purchase of BNSF Railway, at a time it was highly valued in terms of its intrinsic value. The company is now valued at three to four times more than its purchase price, making most of the economic and investing data just noise.

Pabrai also points to Buffett’s acquisition of Coca-Cola (KO, Financial) in 1988. “Do not try to figure out the future of the country or the world, focus on the business,” he says, “It is the performance of the business that matters.”

While he is obviously a fan of Buffett, Munger and Benjamin Graham, Pabrai also admires other gurus. He studies their records and activities, dissecting their successes and their failures, because each creates a learning opportunity.

And he has become well known for his investment checklist(s), which contains some 100 checkboxes, a list like those used by pilots before takeoff. Jae Jun at Old School Value reports that Pabrai found most mistakes made by guru investors fell into five types:

  • Valuation.
  • Leverage.
  • Management and ownership.
  • Moats.
  • Personal biases.

There are all sorts of ways to learn about value investing; Pabrai has taken a somewhat unique approach by studying the mistakes of experts like the investing gurus (including his mentors Buffett and Munger). But like these two gurus, Pabrai makes a distinction between investing and buying a business.

Pabrai’s holdings

GuruFocus reports that the guru operated, as of June 30, a portfolio of just six stocks, of which Consumer Cyclicals make up nearly 70% of the total:

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These are the six stocks which Pabrai held at the end of June:

Remarkably, Pabrai operates one of the highest-conviction portfolios among all the gurus. Such conviction, of course, indicates a high degree of confidence that can only be drawn from extensive research and knowledge.

Pabrai’s performance

Since Pabrai operates his portfolio/funds as hedge funds, he is not subject to the same regulatory filing requirements as mutual fund advisers or managers. As a result, we do not have much information about his year-to-year performance. Some observers have gleaned results:

Holly LaFon of GuruFocus reports the following year-to-date (June 30) results:

  • PIF2 Fund: 28.9%.
  • PIF3 Fund: 28.6%.
  • PIF4 Fund: 20.4%.

LaFon says this information is based on information from people at the firm.

In a 2013 article for Forbes, investment adviser Phil DeMuth stated, Pabrai’s “long-only equity fund has returned a cumulative 517% net to investors vs. 43% for the S&P 500 Index since inception in 2000. That's outperformance of 474 percentage points or 1,103%.” (He disclosed that he and/or some clients are long Pabrai’s fund or holdings.)

While the details might be argued, all observers see Pabrai as generating outstanding results for his clients, giving them multiples of the S&P 500 returns. What’s more, those clients pay just a quarter of what Pabrai generates above 6% if he generates more than 6%, which he has obviously done for many years.

Conclusion

One of the few problems with the Pabrai story is that his fund(s) is now closed to new investors, making it inaccessible to other investors.

It’s worth noting, though, that Pabrai references a 2008 study by Gerald Martin and John Puthenpurackal that found mimicking Buffett’s Berkshire Hathaway (BRK.B, Financial) portfolio could produce outsized returns that easily beat the S&P 500.

This suggests that retail investors or professional fund managers might mimic Pabrai’s concentrated portfolio, even if means waiting weeks or months after he bought or sold (note this is not a recommendation, just an observation and should not be attempted without due diligence). GuruFocus offers lists of Pabrai’s transactions as well as articles that provide context to the transactions.

Incidentally, Pabrai thinks it is a good idea for new investors to buy into index funds, saying it is not easy to be a weekend investor. In a quotation collected by Rupert Hargreaves, Pabrai points out that Buffett and Munger read 100 years’ worth of annual reports before investing in Coca-Cola.

Pabrai has been and continues to be an outstanding investment manager, outpacing no doubt many of his peers and individual investors. His approach and philosophy deserve further study.

Disclosure: I do not own shares in any of the companies listed in this article and do not expect to buy any in the next 72 hours.