Circle Of Competence Issue #18
DEPARTMENT OF GENERAL FINANCE
This is just a fantastic interview with Mohnish Pabrai, founder of the Pabrai funds. He is a fantastic investor with phenomenal returns since 1997 (north of 20%+ annually). I am going to write a small bio next week on him, but for now, this should suffice. A few themes and quotes stuck out to me, namely his checklist approach to investing, his no-fee-based incentive fee only system, and his portfolio allocation (ZERO $ in the US!).
Quote on finding good managers in mediocre industries:
"For example, the quality of management, the durability of the moat, and those sorts of things. I’ve learnt that if you get exceptional managers, and even if they don’t have such exceptional businesses that they’re running, they will produce some incredible results. Sometimes jockey bets - paying out for the right jockey, is a great way to go."
This seems to be in direct contrast to Buffett's well-known quote that when good managers tackle industries with bad economics, it's usually the industry's reputation that stays intact. Interesting that Mohnish has found the opposite to work. I think that on a LONG (10+ years) term basis, Buffett's argument probably wins here. But when you have a great operator in a tough industry that has a short term spurt of good performance or growth or capacity constraint, you can have some winners (e.g. insurance).
Another good one on his checklist items:
"The biggest area of why business or investments don’t do well is leverage. Leverage is generally the one that I’ve had the most difficulty with in the past. There are a host of questions related to leverage, debt and that genre. The second area is a toss up between management and ownership or comparative advantage and the durability of the moat. Those three areas, leverage, management / ownership, and comparative advantage / moats, make up 70-80% of my checklist."
On his portfolio concentration:
"I think that very few people run as concentrated as I do. By the time you get to my 6th position, that accounts for 75% of the portfolio. We do have between 15 and 20 names in the Pabrai funds portfolio, but numbers 6 through 18 altogether are less than a quarter of the pie. By the time you get to the 9th or 10th position, it’s well past 90%. The top two positions, top two or three, might approach 50% of the portfolio."
On his performance fee:
"At Pabrai Funds, we have a 0% management fee, and a 6% hurdle, with a highwater mark, and then I get one third of above 6%. And from 1999 when I started to about 2007 I was paid very well because the funds did very well. But from 2007 to about 2017, 10 years, in one of the funds we collected no fees. That was correct because I was below our 6% annualized watermark going up from 2007, and when we finally got past that in 2017, and I got paid quite nicely."
Another fantastic piece by Ensemble Capital discussing the differences between optimizer (capital allocator) CEOs and visionary (innovator) CEOs. Wonderful insights - I highly recommend adding this powerful dichotomy to all investors’ slate of mental models.
Wonderful interview with Kevin Clayton about what it is like to be owned by Warren Buffett's Berkshire Hathaway. No meetings, no budgets, no projections. This gives a good glimpse into how decentralized Buffett's management setup at Berkshire truly is.
Great little article from Morgan Housel on the lessons all investors can learn from the Theranos debacle. I encourage all readers to do yourself a favor and research the terrible things that were done to keep the investors and consumers in the dark about Theranos’ product. Also, Charlie Munger discusses in his famous speech on psychological biases (issue 16) how denial of reality can distort someone’s perception and therefore their actions. Clearly, the bias of denying reality bore fruit of terrible proportions at Theranos.
Are companies manipulating earnings? One academic study says they may be...
The yield curve continues to flatten. Recession signal or just a head fake? I tend to trust historical indicators that have been correct 90% of the time since the 1950’s when economists began tracking this measure of financial market health.
At first blush I could see a lot of high net worth investors getting behind this incentive to reinvest in regions outside of metropolitan areas. However, second order consequences of policies like this tend to be harder to predict or quantify. Will this motivate the right type of economic growth that is shared by investors and the communities alike or will this simply become a long term tax avoidance scheme without really aiding the opportunity zones? This will be an interesting trend to follow.
Eric Cinnamond is a talented small cap investor and has been featured on the Investors Podcast (issue 16). In this piece, he shares a few thoughts about returning his capital to outside investors even S valuations continued to move higher and higher due to the fact that he simply couldn’t find new investment ideas worth investing in with client capital. Highly recommended!
DEPARTMENT OF REAL ESTATE
The negative trend in occupancy seems to be caused by changes in Medicare/Medicaid reimbursements and due to budgeting constraints taking place in the two programs. However, the long term outlook seems to be stable due to the continued graying of Baby Boomers.
Great article about the oversupply in the apartment rental space. Interesting to note that there are over twice as many apartment buildings being built currently as compared to the historical norm. From multifamily investors I’ve spoken to, this seems to be a concern in larger metropolitan areas but less so in more rural areas and smaller markets.
DEPARTMENT OF TECHNOLOGY AND STARTUPS
Fascinating new company that is employing autonomous drone technology applied to logistics and shipping for hospitals. This is the future of delivery.
870 million users. 1.6 trillion yuan in assets under management ($271 Billion). Insurance. Consumer loans. This is a what the tech enabled future of finance is starting to shape up to be.
Compelling read on Google’s Medical Brain team and how they are using huge amounts of unlabeled, unstructured data to predict death probability of patients.
DEPARTMENT OF PODCASTS
Wonderful podcast discussing the following five questions:
1. Elon Musk vs. Buffett on moats. 2. Question on bitcoin's usefulness as an investment.
3. Question on 401K options for BRK.A employee and why the subsidiary doesn’t have index fund options. 4. Question on value investing, CFA, and MBA programs. Wonderful discussion on Ben Graham and his investment philosophy as well as modern finance theory. 5. Question for Charlie Munger on machine learning and artificial intelligence and how it factors into capital allocation.
In this episode, BiggerPockets hosts Brandon and David interview Paul Moore from Wellings Capital (wellingscapital.com). He is a very experienced multifamily operator and this is a fantastic story about his transition through various types of real estate including house flips, single family rentals, all the way to large multifamily syndications. I have had the opportunity to speak with Paul over the phone and personally attest to how smart of an investor he is. My favorite quote is at the beginning of the podcast where he explains the difference between investing (where your principal is NOT at risk and you have the opportunity to make gains) and speculating (where your principal is at risk but you could also potentially make gains). This might be the most important, fundamental concept of investing, and goes all the way back to Benjamin Graham's formulation of investing in the Intelligent Investor and Security Analysis. Highly recommend!
DEPARTMENT OF BOOKS
Warning - this book is for nerds! But, if you love learning for the sake of learning, AND you weren't a physics major in college, you'll enjoy this set of lectures by Richard Wolfson. He masterfully leads you through a brief history of physics from Galileo to Einstein's relativity and quantum mechanics and ends with the standard model of particle physics and the unification theory (of everything). Highly recommend this for folks looking for a gentle intro to the big ideas in physics.
DEPARTMENT OF LETTERS
I've been following this activist situation for a few weeks now, and boy has it been moving quickly! Check out the last couple of issues to see other letters between Carl Icahn and SandRidge's management. Long story short, Icahn won the majority of board seats at the June 19th annual meeting and is pushing for any and all types of transactions to realize value for shareholders. This includes asset sales as well as a sale of the entire company. According to the release, they have confidentiality agreements with over 20 parties looking into a potential transaction with the SandRidge. This story should continue to be interesting to watch to see what potential transactions come from the review process (Disclosure: long SD as of this writing).
My scratch notes on decades worth of Fairfax Financial Holdings (Prem Watsa) and Wesco Financial (Charlie Munger) Shareholder Letters below: