Labor day Sunday background music: Allman Bros. with Eric Clapton Live March 20, 2009 “Dreams” At 70 EC has declared he’s tired of the hassles of the road and no more extensive touring. The Allman’s have lost both primary lead guitarists as well. So at least we have great live recordings.
Otherwise there is a poignant article in Forbes today: “How Mohnish Pabrai Crushed the market by 1100% since 2000. Apparently Pabrai’s long-only equity fund delivered 517% to investors versus 43% for the S&P 500. Further validation that Index only investing is not just one of the laziest ways to invest but one of the poorest. BTW Pabrai’s fund is closed to new investors – smart so as to not dilute returns for the earlier investors.
Pabrai talks about his base method, should we call it a “system”, because it most certainly is. His primary method is based on the strategies of Warren Buffet in his letters to shareholders. And, he confesses that investing is not an “originality contest” by which he freely appropriates the ideas of others. The structure of his fund is based on the Buffet partnerships of the 1950’s and he lifts investment ideas from such notables as Seth Klarman of Baupost and Joel Greenblatt of Gotham and author of “The little book that beats the market”.
But the most important lesson from this article is Pabrai keeping his nerve and sticking to his strategy when times were frightening in 2008 and his fund was down 60%. Personally speaking, I don’t believe its wise to hold on to equities when a recession is on the horizon but I have enormous respect for Pabrai to continue to hold and add to his positions despite the decline.
The point I’m trying to make is that there are significant commonalities between Pabrai’s fund and OP:
1. Style points are not given to originality. While we have created and developed original equity ranking and trading systems we love to use ranking systems invented years or decades earlier whereby we can develop, modify or improve. Older systems developed by Greenblatt, Piotroski and others have the advantage of being real time tested for 20 years or more. We have modified and actively use Greenblatt’s “Magic Formula” as a 5 stock system in client accounts. The Magic Formula represents one of the finest large cap value systems* we’ve ever come across and to not use it for our clients benefit would be a shame.
*Note: If you read the Magic Formula book or visit the website where you can see a list of qualifying stocks you need to understand that what you’re looking at is merely a display of the Magic Formula ranking system. A ranking system alone is not enough to effectively manage a portfolio, a Trading system must be developed and integrated with the ranking system for effective management.
Professor Joseph Piotroski formerly of University of Chicago and now Stanford developed an excellent small cap ranking system as well, which anyone can easily Google and download. The “Piotroski F-Score” is an excellent tool but at present it is “on the bench” since we have our original small cap systems which outperform the Piotroski’s.
2. Once a plan is in place STICK TO IT: Investment pro’s hate to say this but all the time tested investment strategies are still at the whim of the investor who makes emotionally based decisions. Odds are very high that if an investor quits a strategy its likely during a period of duress and the client is in panic mode. Know anyone who sold in 2008? How long did they take to buy back in? Its never a matter of days or even months, its always a matter of years at the cost of huge lost opportunity had they just done nothing.
A fact that really surprises potential investors when we show them the details is that how little long term returns are affected by avoiding major market declines like 2008. While its likely we’ll never see anything like ’08 again, the effects of a well hedged portfolio versus un-hedged are small. However we feel that a client knowing a hedge can be effected is more likely to ride through a bad patch and not panic.
3. No shock to see that Pabrai’s fund may only own 10 holdings at a time. Our own testing has shown that 10 can be an optimal number of holdings in a given system. However, we’d prefer to have our clients diversified amongst multiple systems rather than a single system. But if the method is sound there no reason that 10 cannot work.
Summary: There is no such thing as a single best method to invest. We would never be so foolish to say that our methods are the best as I’m sure better systems or methods exist. I only say that the systems we use are the most effective I’ve tested and aware of. What the common adage that comes with age: “The more I learn the more I realized what I don’t know.”
There are many methods that work well but there there are also a few common traits investors must have. From my experience patience and persistence are at the top of the list.
Be careful out there
Brad Pappas
BTW the 200