The Portfolio Strategy of Mohnish Pabrai

Wall St. Nerd

A.Kelm

Updated on

January 13, 2023

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Mohnish Pabrai is one of the most successful value investors in the world. Since his start in 1995, he has achieved an average return of about 26% per year by copying Warren Buffett's approach (at least according to himself). When his portfolio strategy turned out to be too risky in 2008, Pabrai made some significant adjustments and enhancements to his strategy. This enabled him to reduce his permanent capital losses to about 1% of his portfolio, as well as manage cash very efficiently.

Mohnish Pabrai, by the way, is also the guy who paid USD 650,000 to have dinner with Warren Buffett and the one who wrote the famous value investing book "The Dhandho Investor ".

In this article, I would like to take a closer look at Mohnish Pabrai's portfolio strategy and the key success factors.

What you will learn in this article

  • What Mohnish Pabrai's investment approach looks like and how he sets his targets
  • More about Mohnish Pabrai's track record
  • How Pabrai's has adjusted his portfolio strategy since 2009

Background of Mohnish Pabrai

Mohnish Pabrai started investing in 1994-95, when he had just sold his IT business and had about USD 1 million in the bank.

Sometime earlier, Pabrai had started studying Warren Buffett and his investment philosophy. In the process, he realized that there was actually no one else besides Buffett himself who was applying Buffett's strategy in practice. Therefore, Pabrai decided to be the first here and copy Warren Buffett's approach.

His long-term strategy is to turn USD 1 million into USD 1 billion within 30 years. The required return for this is 26% per year, or a doubling of capital within about 3 years.

"Take up one idea. Make that one idea your life - think of it, dream of it, and live on that idea. Let the brain, muscles, nerves, every part of your body, be full of that idea, and just leave every other idea alone. This is the way to success." Swami Vivekananda

Following Swami Vivekananda's mantra, Mohnish Pabrai has been focusing exclusively on this goal ever since.

Track Record

After 4 1/2 years in business, i.e. at the end of June 1999, Pabrai's portfolio had already reached a value of USD 5.1 million. This was equivalent to an annual return of 43.4%. Pabrai owned two stocks during this time, each of which had increased in value more than a hundredfold. Unfortunately, Pabrai's investment in just these two stocks was quite small. However, he also profited from the internet hype, buying shares cheaply and letting others drive the shares up.

On 1 July 1999, Mohnish Pabrai then founded Pabrai Investment Funds. In the first 8 years of its existence, i.e. until the end of June 2007, the fund achieved a return of 29.4% p.a. after fees (approx. 37.2% before fees).

Then came the financial crisis and with it the big collapse in the portfolio: Between 1 July 2007 and 31 March 2009, the fund achieved a return of -47.1% as a result of the crisis.

After that, things went up again until March 2013 and Pabrai achieved a return of approx. 32.7% p.a..

All in all, the return between 1995 and 2013 was about 25.7% per year, almost the targeted 26%. Quite an impressive result in my opinion.

Target: At least doubling of the investment within 2-3 years

As we have seen, Mohnish Pabrai has set himself quite an ambitious absolute return target (namely 26% per annum), which he has derived from his specific goal of doubling the portfolio a thousand fold within 30 years.

In his view, you cannot beat an index by trying to beat the index. Instead, investors should rather set absolute return targets.

Basically, this means nothing other than that we need a somewhat different investment approach than, for example, the one regularly suggested by the financial media.

If we want to achieve an appropriately high return target, we must only buy shares that we believe can at least double or triple in value within a maximum of two to three years.

If all our investments were to double in value within three years, we would have just reached our target return: 1.26 * 1.26 * 1.26 -1 = 1.00 or 100%. In reality, there will be a few investments that don't work out so well. But a few will hopefully also perform better, e.g. double in value more quickly or the like.

Conversely, this also means that if, for example, a share costs USD 10 and we think it could be worth 13, 15 or USD 17, we should not spend time analyzing the share. Which is quite unusual, of course, because such shares are usually seen as very good investment opportunities and the stock market media are full of them.

So a good understanding of the intrinsic value of a share is the essential prerequisite for this approach.

Efficient cash management through staggered return targets

Buying only stocks that can at least double in value within 3 years is already good. But Mohnish Pabrai goes one step further. To manage his portfolio cash efficiently, he has set even more demanding return targets for the last 25% of the portfolio cash.

For the first 75% of the cash, Pabrai sets the minimum return of 100% in 3 years (i.e. 2x) as described above.

The next 10% is only invested if a stock offers the potential for a tripling of the stake (3x) within 2-3 years. And so on. Here is the summary:

Return targets Mohnish Pabrai. Source: Lecture at Columbia Business School

So if say 85% of the portfolio value is invested, then we need at least one investment with the potential to quadruple the stake (4x), otherwise we stick with cash.

This approach essentially means that there is some cash in the portfolio at most times, simply because the appropriate investment alternatives are lacking. Actually, there has to be a major economic crisis like in 2008 for the portfolio to be fully invested (because only then are there enough investment opportunities with a corresponding return potential).

Copying the ideas of others

Of course, it is difficult to find an investment with a potential return of 2x or 100%. However, of the more than 50,000 listed companies worldwide, we only need to invest in 2-4 per year (or less).

To illustrate how we can find such investments, Mohnish Pabrai quotes one of his role models, namely Charlie Munger, Warren Buffett's partner at Berkshire Hathaway. Pabrai once had dinner with him, during which Munger spoke about the 3 essential investment strategies:

  • Invest in cannibals, i.e. companies that buy back their own shares in a big way
  • Invest in spinoffs
  • Be a free rider - copy what other top investors are buying

According to a study by the University of Arizona, an investor who consistently copied Warren Buffett's strategy would have beaten the S&P 500 by 11%. In fact, we only need to look at the 13F reports to find out what investments Buffett (or other well-known investors) made last quarter.

"Take a simple idea and take it seriously." 

Charlie Munger

Learnings and adjustments of the strategy due to the financial crisis

After Mohnish Pabrai's portfolio suffered a loss in value of almost 50% in the 2 years following the outbreak of the financial crisis, he began to analyse the situation. One of Pabrai's key guiding principles is that knowledge accumulates.

To date, he had about 10 stocks in his portfolio at a time with an allocation of about 10% each (10×10).

Based on his analysis, he identified 2 weaknesses of this approach:

  • The portfolio was riskier than expected because some stocks had received too high an allocation (namely 10%).
  • The portfolio had no (or only a very small) cash balance, which made it somewhat more difficult to take advantage of the favourable prices in 2008 and 2009 (at that time, all good companies were actually available at a knockdown price).

Mohnish Pabrai's first reaction: further diversify the portfolio, i.e. no longer have only 10, but perhaps 20 stocks in the portfolio, each with a lower allocation. You can see this effect clearly in the number of portfolio holdings, right after the financial crisis:

Number of shares in Pabrai Funds. Source: Dataroma.com

At that time, Pabrai was logically fully invested. But he made other changes to his strategy. First, he introduced his infamous pre-investment checklist that year, and second, he has since been having a pre-investment conversation with another investment manager or investor to test his idea.

These two adjustments have resulted in the permanent capital loss - a risk indicator - in the portfolio shrinking to less than 1% of the portfolio value.

Current holdings

As already mentioned, Mohnish Pabrai's portfolio is currently quite concentrated. On the one hand, Mohnish Pabrai currently only has a total of 3 stocks in its portfolio, and these are Micron Technology Inc., Seritage Growth Properties and Alibaba Group Holdings.

Here is the data on Dataroma's portfolio:

Current holdings Pabrai Funds. Source: Dataroma.com

Further resources on Mohnish Pabrai

Lecture on value investing at Columbia Business School

The Dhandho Investor

Mohnish Pabrai interviewed by Forbes (a very interesting interview with many insights on his investment strategy):

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Hi, I'm Alexander Kelm.

Serial entrepreneur, value investor and angel investor. Founder of Wall St. Nerd. Join me here on wallstnerd.com to learn how to read financial statements, find healthy companies, and invest your money wisely.


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