Mohnish Pabrai is one of my favorite current value investors to follow. He has one of the best track records over the past 15 years. One of the reasons I like him is that he came to the hedge fund world from the business world. He never worked on Wall Street, and I don’t believe he has an MBA. He worked as an entrepreneur, starting his own company in his 20?s, and then selling it a few years later, pocketing around $1 million personally.
A couple months ago I watched this video of Pabrai giving a lecture at Columbia. I’ve talked about Pabrai’s ideas before on this blog, but I thought this lecture was by far the best I’ve seen regarding Pabrai’s background and how he got his start as a value investor. His comments on compounding are also very interesting…
Pabrai mentioned that in 1994 he began reading about Buffett, and became amazed at Buffett’s ability to compound capital. He did a study on Buffett’s performance beginning in the early 50?s (even before Buffett started his partnership when he was making his 50%+ annual returns).
The ExodusPoint Partners International Fund returned 0.36% for May, bringing its year-to-date return to 3.31% in a year that's been particularly challenging for most hedge funds, pushing many into the red. Macroeconomic factors continued to weigh on the market, resulting in significant intra-month volatility for May, although risk assets generally ended the month flat. Macro Read More
Compounding-The “8th Wonder of the World”
Buffett had incredible returns that absolutely stunned Pabrai:
- 1950-1956: 43.0% annualized
- 1957-1964: 27.7% annualized
- 1965-1993: 29.1% annualized
These results would inspire a very green Pabrai to think that he could replicate these results. Pabrai set out to play what he called a “30 year game“. Specifically, he decided he wanted to compound his $1 million at 26% per year for 30 years (he chose that number because that’s about what Buffett was doing and 26% per year doubles every 3 years).
The interesting thing is… he is actually replicating these results after 18 years! Take a look at how Pabrai breaks down various periods of his career thus far:
- 1995-1999: 43.4% annualized
- 1999-2007: 37.2% annualized (he started Pabrai Funds in 1999 and this is before his fees)
- 2007-2009: -41.7% annualized
- 2009-2013: 32.7% annualized
All together, since the game started, he’s made 25.7% per year over 18 years. So far, he’s on target, which is incredible to think since his initial goal was 26% per year, which many probably would have called naïve for a guy with no experience and no track record.
One of the things I found interesting was how he noticed that mutual funds were primarily index hugging vehicles that didn’t provide much value. He noticed that Buffett invested very differently than the mutual funds. “I found that the entire fund industry worked a certain way, and that their results reflected the mediocre way in which they operated.”
So he went from not having ever heard of Buffett in 1994 to deciding that he would spend the next 30 years of his life investing, to now having achieved an 18 year track record of nearly 26% per year… Incredible….
How Did Pabrai Achieve Incredible Investment Results?
Here is how Pabrai summarized his presentation prior to the Q&A:
- “Take one idea and take it seriously”
- Remember the power of compounding
- Clone the best investors
The investing process is quite simple. The key is to keep practicing it and continue to learn. Make smart, easy-choice investments based on cheapness and quality, and keep the big picture in mind.
Also, remember that to make 26% per year, you have to do things differently. Pabrai said that to beat the market, and to compound at 26% per year, you have to:
- Don’t try to beat the market. Think in terms of absolute targets.
- Don’t buy anything that is not going to go up 2-3 times in the next 3 years or less.
These last two bullet points were perhaps my biggest takeaways from the lecture. I’ve written other posts regarding “thinking differently” (like Munger when he paraphrases an old 19th century mathematician: “Invert, Always Invert“).
Those two points are not what you normally hear from other investment professionals. But it is that type of thinking that has enabled Pabrai to make 25.7% gross annual returns.