Post Pandemic Views & Investment Journey - Mohnish Pabrai
Radhika Gupta, CEO of Edelweiss Asset Management, and Mohnish Pabrai discuss bridge, Dhandho investing, Mohnish’s lunch with Warren Buffett, the importance of patience in investing and the current investment landscape.
Quest by Radhika Gupta: In order to start this conversation with a quote that she has heard from mohnish pabrai and this is something very close to her, you said that the good news in investing is there are no HR problems because if there are no humans there are no problems. So if we want to know why Mohnish Pabrai chose investing as a career because he actually started out in sales and marketing and then he did entrepreneurship and then turned investor so how his professional journey took a turn?
Answer by Mohnish Pabrai: So most of us when we grow up we basically tend to confirm what the world expects of us or how the world expects us to act or behave or things to do and so on so forth.
So each of us as humans has a some has a kind of let’s say core map of who we are on the inside and then there is how we act on the outside and the problem with the map that we have,on the inside of who we are the theory is that it’s hard-coded at the age of five between your genetics and first five years of life experience and after that it’s not going to change for the rest of your life.
So it’s pretty much set in stone the problem is that most of us do not know ourselves well enough to know what that inner map is,so we go through life and that would be called as misaligned.
So for example if you have this as your inner map and this is your outer map this is typical in almost most humans there’s misalignment and if you can get to inner and outer aligning really well which happens in a lesser of humans you can go really far in life because then you’re maximizing all.
You know capabilities and you know preferences and what you love to do and so on.
In 1999 so when he was 34 years old and that’s when he actually got a document which gave him his inner map and a lot of things that he had been doing until then were not in sync.
So you cannot change your inner map it is what it is and and the best that you can do is make the way you go through life be as closely aligned as possible to that in a map.So one of the first thing that two psychologists had told him because he was just about to start Pabrai Funds it was about three months before pabrai funds – started and while then he was running an IT company with 160 people and they said to him that they actually don’t even understand how he was able to function in this environment with all these people because so far away from where he was and they said that they know it’s not possible for a guy like him to involve with so many people altogether.
Mohnish Pabrai described to tell them what Pabrai funds were going to look like and they said that looks perfectly aligned with what his inner map is and in fact one of them became one of the original investors in Pabrai funds.
Quest: Let’s know about Entrepreneurs,you’ve had this belief that entrepreneurs take risk and people think they take risk and they get rewarded because they take risk but in reality and entrepreneur wants to do everything to minimize risks they want free lunches,if they can get them and go after them but is this the whole Dhandho investing framework that you talked about in the book and actually what is the story behind the framework in the name ?
Answer: The common misconception is that entrepreneurs take too risk and so if we ignore venture-backed startups which are a completely different animal they represent less than 1/10 of 1% of all startups so we can we can ignore venture-backed startups they don’t represent the reality of how 99.9 percent or more of businesses get started.
So for an example of let’s say a dry cleaner for example so there are two towns they’re like 20- 30 miles apart and they have dry cleaners in both those towns and then there’s a new Township coming up between those two towns let’s call it town C and town C is coming up and this one cleaner notices that some people are driving quite a bit of distance to come to him because there’s no dry cleaner than so he starts questioning the people there , that basically there’s an opportunity because there’s not writing is there so he might he might open a small shop there it might not even have any facilities just might be a place to take in and deliver clothes but still keep the back end at his main place he could minimize a risk of doing that by you know keeping the lease short and keeping the space small and so on so forth and then once it gets going he can scale that up and if it doesn’t work he can pull that back and just go back to the way he was operating.
So basically the idea is that being an entrepreneur it doesn’t matter you know you’re running a restaurant or a gas station or whatever basically the the idea is that entrepreneurs look for arbitrage opportunities and as we understand arbitrage in markets pure arbitrage is risk and entrepreneurship is not risk-free but it’s pretty low risk in the manner in which most entrepreneurs approach it so they try to do all kinds of things to make sure that the the downside is limited.
Now coming to the word Dhandho so Mohnish Pabrai had one of his roommate in college was a Gujarati guy in college in South California and he had a bunch of relatives uncles who had different businesses motels laundromats you know 7/11 so on and so several times on the weekend he would disappear to meet different family members and come back Sunday night he’d be like have all these stories of all these deals his relatives his uncle had to bought a new motel or whatever and then the end when he finished telling me all those stories. Later he would say Mohnish dhandho okay ! The Dhandho Gujarati word that the direct translation is business but we know that what it really means is an approach to doing business which gives you upside the downside.
Quest: Entrepreneurs money when you practice and approach that’s upside with more downside and you say heads I win tails I lose I think it’s very relevant for a market like India which is so chaotic.
I mean it’s economically chaotic it’s also politically chaotic now how do you actually practice that kind of investing so do you have a checklist in mind and if you had to give people a bit because that’s what everyone’s trying to achieve in a market like India how do you practice that ? Is there a checklist that you have? What are the few things that you tell people who want to practice that kind of investing?
Answer: The checklist comes in a little later in the process as in the sense that you’re trying to make sure you’ve thought about all the things you should think about before making investment.
When you first encounter a business as a potential investment ,the first question you should be asking yourself is how would I lose money on this investment ? Not how I would make money but what are the ways in which things can go wrong and after that you can satisfy yourself that you can’t easily come up with a scenario where things can go wrong.
Focus on the downside,upside can take care of itself.
So what we really want to do in investing is we want to look for investments where the downside is very muted.
Quest : One question I had is and this is the obvious question about crisis obviously you’ve seen 2008 you’re seeing the current crisis around over you know whatever mistakes you’ve made in 2008 that you learned from and you feel that you held up better because of those during this period?
Answer: We’re still going through the period.
For time will tell but the number one area which had trouble in portfolio has been making investments in leveraged businesses and buying leveraged financial institutions.
As Mohnish Pabrai runs a concentrated portfolio typically of ten investments, I think if the lesson I took from there is to stay as far away as I can from leveraged institutions and from in general staying away from all type of leverage business.
He doesn’t have any leverage in his portfolios and personally have no margin or anything like that. We don’t go there but just want to make sure that even the businesses we get into typically are not in that space and you know when he talked about the checklist earlier.
The number one reason that value investors don’t do well on their investments is leverage they were like four or five large reasons why investments don’t work out leverage was the number one you know some aspect of management of ownership and their ethos was another one and then you know some aspect of the moat , misunderstanding the competitive advantage was another one so these are three big ones but leverage is the biggest biggest one.
Quest: Is this post pandemic and this crisis is different from 2008 crisis?
How do you see it is different? I mean do you think is there a post covid investing world or is that too big of phrase describing too much to this current crisis?
Answer: As of now, as we all know India loses about a hundred – thousand businesses a year that just happens normally in a normal economy in the US and we create more than 1,00,000 businesses then that whole creative destruction is what makes the economy destroyed way more than hundreds of businesses we’ve destroyed.
In his opinion probably hundreds of thousands of businesses and many of those will never come back because they are very fragile and to begin with you know you take some restaurant or some barber shop and such I mean these are difficult businesses they’re surviving in a steady state in a very competitive environment it’s hard to know it takes the pull the rug out from under them and have them come back.
India’s unemployment rate remained steady at 23.5% in May 2020, according to a survey conducted by the Centre for Monitoring Indian Economy (CMIE). This was not a significant deviation from unemployment numbers in the previous month.
So I think that the recovery even though governments have taken very good action in terms of you know supporting it and supporting the financial system and all that in the u.s. we were at you know three odd percent unemployment we had the best job market in January in the history of the United States.
It was just the the most amazing economy more than 160 million people employed we will probably not see that again in my opinion at least for at least five years and it may be beyond that might even be ten years so it’s hard to know how long it will take the United States to get back to three % or for India to get those 100-125 million people back to work but it’s not going to be this year it’s not gonna be next year it’s not gonna be it will not be whenever you’re vaccinated we have created serious permanent damage to the global economy.
Quest: A related question from an Indian investor. What you know is one of the things that the Indian investor has been looking at and many people listening on the corners, they’ve been looking at the US market and you know you talked about the economic damage?
So how do you see the US market and the way it’s moved and it’s hard to talk about this given what has happened to the economy and the economic impact and for someone sitting in India who’s looking to invest in the U.S also which is a lot of people today?
Answer: So the the US markets for the most part have brushed off covid as an ordered event. I mean if you look at the decline in the stock indices on March 23rd was low but the economy’s come I mean the stock markets come rolling back a lot of good news is priced in and to some extent some of that may be justified because markets are forward looking.
I think the United States is a you know superhuman economy it’s a superstar economy it’s the best most amazing economy on the planet with all the factors you know set up to unleash all the entrepreneurial energies of the country and such so it’s it’s an amazing creation will bounce back and the American spirit they will try to bounce back as quickly as possible. I think even two years from now we’ll still be maybe at 7-8 % unemployment.
Quest : Markets have accurately discounted the macro covid events sitting in the US how they look at India I think India obviously is an economy that was probably in tough shape going into orbit we’ve been in the midst of a credit crisis since 2018 are there bright spots that you see in India and how do you see India kind of coming out of this ?
Answer: India does a lot of self-inflicted wounds on itself so, for example we know that there is an excellent exodus from manufacturing in China that started happening after the US government started imposing tariffs and there were lots and lots of companies that were looking at alternative places to China so they could continue to manufacture at competitive rates.
Vietnam for example picked up massive amounts of manufacturing from China and India for example picked up very little and the reason India picked up a little is we make it really really hard to attract foreign investment we have so many rules that are backwards and laws that are backwards and they defy Ricardo they defy Adam Smith meaning the the mantra for how to make a country rich is extremely well known you can study Lee Kuan Yew and you’ll get there you can study Augustine Pinochet you can study the Chicago economics school you can study Adam Smith you can study Ricardo none of these models is what India photos and it it blows my mind.
That it’s not like we have a lack of brains or at the center we have a lack of understanding of what makes an economy tick and how to make an economy like India work really well and grow really go at very high rates and some of that gets to work bank politics where once you start focusing on those types of factors then you can forget about great economic results or great growth rates.
Disclaimer: The whole summary is based upon my understanding from the session taken by Radhika Gupta on 29 May 2020. Detailed video of the above long summary is available .
For a complete detailed session do watch their video.