The most intriguing performance of Mohnish Pabrai’s Investment Fund in the last five years was its free fall in 2008 where it disgracefully lost 60% of its value, followed by the outstanding rally in 2009 when it returned well over 100%. Even that performance of 2009 could not eclipse all of the losses from 2008. The spreadsheet below details the valuation of his holdings from 2007 to 2009:
[Click all images to enlarge]
- The 10x10 portfolio allocation resulted in a small number of huge concentrated bets. This lack of diversification is naturally more volatile than the overall market.
- Pabrai’s portfolio sported a small-cap bias that sent his picks downhill faster in a bear market or uphill sooner in a bull market than the overall market.
- Pabrai had huge bets on a couple of highly leveraged small-cap financial companies that went bankrupt.
To analyze how Pabrai lost and then recovered a lot of his portfolio value in a two-year span, we evaluated his portfolio by comparing the top-5 holdings at the beginning and end in each of the following three sub-periods in the 2007-‘09 timeframe:
- End of 2007 to the conclusion of the third quarter of 2008,
- End of the 3rd quarter of 2008 to the finish of 2008, and
- End of 2008 to 2009 completion.
End of 2007 to the conclusion of the third quarter of 2008:
- There was a 20% drop in portfolio size,
- The portfolio holdings remained almost steady, although there was one major sell (ABX Holdings) followed by acquisition of Berkshire Hathaway (BRK.A) shares. (Pabrai held Berkshire Hathaway shares as a store of value.)
- Pabrai made a small (~1%) investment in Compucredit (CCRT) in April 2007 at $34.03 per share. By the end of the 3rd quarter of 2008, this stake had been increased to almost six times, bringing the Average Purchase Price to $24.19. The stake was liquidated in the following year at an Average Sale Price of $6.81 for an overall loss of over 70%. At the 2009 annual meeting, this investment was acknowledged as a huge mistake.
- The portfolio size dipped by over 55%.
- A number of new investments were made in the metals/mining/natural resources and financials areas during the quarter. Those areas took the brunt of the market correction and it is no surprise Pabrai found the biggest bargains there. How Pabrai raised cash for these investments in that quarter is a primer for individual investors – he disposed off several defensive positions including Berkshire Hathaway, Fairfax Financial Holdings (FRFHF.PK), and Wellcare Healthplans (WCG).
- The portfolio allocation shifted somewhat to have a large-cap bias with new investments in Goldman Sachs (GS) and Potash (POT). Those accounted for almost 15% of the total portfolio value.
- The portfolio size increased by over 120%,
- The positions in Air Transport Services (ATSG), Horsehead Holding (ZINC), Pinnacle Airlines Corp (PNCL), and Teck Cominco (TCK) returned well over 200% each for the time period and collectively accounted for a quarter of the total portfolio value. The new large-cap positions on Potash and Goldman Sachs also showed good returns although no where near his returns on small-cap positions.
- The Potash position was doubled and another large-cap position was initiated with the purchase of Wells Fargo (WFC) during the market lows of March 2009.
To study the effect of the portfolio turnover during the period, here is a look at how the portfolio would have performed, if the positions were left untouched during the period from the end of 2007 to the end of 2009. The spreadsheet below shows the valuation projections:
Below are some observations:
- The size of the portfolio would have decreased by around 21% during the period. The performance would have been comparable to the change in the real portfolio size, assuming no new money was added to the portfolio during the period – Mohnish Pabrai would have achieved similar performance by holding tight on all his investments during the tumultuous 2007-2009 period!
- Mohnish Pabrai’s real portfolio dropped 65% from the end of 2007 to the end of 2008 and rebounded by 128% during the period from the end of 2008 to the end of 2009 compared to 55% and 72% respectively for the untouched version. The size of the portfolio at the end of each sub-period indicates Pabrai would have achieved similar performance with far less volatility, if he had just held on to his investments.
While concentrated bets, small-cap bias, and laying wagers on highly leveraged financial companies were contributing factors to the extreme portfolio gyrations during the 2007-2009 timeframe, one subtle factor was the frenzy of trades. Pabrai’s specialization on ‘Special Situations’ was a major cause for his outperformance during the early years of his investment funds.
The large losses in 2008 prompted drastic changes to the portfolio aimed at reducing volatility and eliminating mistakes. An initial volatility spike due to the numerous trades is a natural side effect. The shift to the 2-5-10 model along with the addition of large-cap stocks to the portfolio has had the net effect of shifting the funds focus away from special situations. Going forward, the portfolio should show less volatility and the funds will likely achieve modest outperformance compared to the major indexes.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I have written cash-covered puts on BRK.A (Jan 2012 75) and WFC (Apr 2012 22).