Mohnish Pabrai blog

[tng]

Not specifically toward Pabrai but more generally for all investment managers:

 

When I usually take a quick glance at any multi-year performance records, say 5-15+ years, my first instinctual response when comparing the annual performance (and volatility) compared to the S&P500 is that it almost always looks horrible.

 

However, whenever I look at the bottom "Annualised" or "Cumulative" performance it looks like they've skilfully beat the index. Is this a mathematical smoke and mirror which doesn't really take into account AUM? For example, if I started managing money and had $10,000 first year which I turned into $20,000, that 100% return would always be in my recurring tally even if, in year 10 say, I was managing $10mil. and had lost 10% ($1mil). I wish there was a way to force investment managers to show the $ returns.

 

But I'd also add that if there had been no real performance, then how can an investment manager with a high-watermark performance fee with no management fee, have made money personally. Surely they must have performed?

 

I think Bruce Berkowitz talked about this. Even many superstar investors end up losing more absolute dollars than they made because they become famous on low AUM and money comes flowing in. They end up with huge AUM, and once they hit a setback, all their clients leave and lock in the losses.. So you end up with more absolute dollars loss, even though the percentage AUM looks good. He said he hopes to avoid that fate, but unfortunately it looks like it happened to him too. The Berkowitz story is interesting because he was absolutely correct to be bullish on banks after the financial crisis and he made a big comeback for a short while. However, because he was losing clients and he was stuck in some illiquid positions (Sears, Freddie/Fannie, St Joe), he actually had to sell off his bank stocks in 2016 which was a low point for bank stocks. If he believed in banks in 2010-2011, he definitely would have loved them in 2016 and many of them doubled up in the next 2-3 years. But he was stuck in Sears at that point.

[thowed]

I don't especially want to hate on Pabrai, but this is becoming a broader interesting talk about fund manager selection, and its pitfalls.

 

Some very nice points - I've definitely invested in a couple of funds with stellar records, skewed because of amazing first year performance.  I think this is a case for man over machine - it's harder to see this in a spreadsheet.  You need to be looking at the performance over different periods, and understand why someone performed the way they did at that point.

 

e.g. First year may be better through a) small AUM, high cash levels in 2008/9.

e.g. You can forgive a bit a conservative fund if they underperform during a roaring bull market, as long as you've seen that they outperform in the bad times and it balances out.  Rare/non-existent is the fund that can outperform in both bull and bear markets.

 

Ultimately, integrity counts for a lot (though strong fiduciary duty doesn't alone make profits).  Independence and incentivisation are also useful.  Keeping an eye on people to make sure they don't get complacent when they're older and richer is important too - there comes a point when successful managers 'jump the shark' - the $$$ penthouse in NYC is often a sign that they're not focusing on their fund as much.

 

 

 

 

[stahleyp]

I wonder how much wealth a lot of these fund managers would have if there were a 3 or 5 year look back. That seems fair. If you take on a lot of risk and have a great year, it doesn't mean you're skilled. Why be paid millions and millions for that?

[Vish_ram]

Q2/2020 out; stunning returns by S&P 500 - total returns that includes dividends

[OracleofCarolina]

https://www.sec.gov/Archives/edgar/data/1549575/000154957520000008/seritage13G.txt

 

going big into Seritage...could work out very very very well or VERY bad

[Vish_ram]

Bring some popcorn

 

Long Brick & Mortar (commoditized leveraged excess capacity play that is burning cash ) and short internet. Interesting possibilities. A covid recovery play along with cruise lines, airlines etc.

 

JCP just announced that they are doing a similar RE play. Macys might soon join this. This reminds me of St Joe, so much promise yet nothing to show for. It takes huge capital to make money in RE development.

 

https://www.sec.gov/Archives/edgar/data/1549575/000154957520000008/seritage13G.txt

 

going big into Seritage...could work out very very very well or VERY bad

[Foreign Tuffett]

https://www.sec.gov/Archives/edgar/data/1549575/000154957520000008/seritage13G.txt

 

going big into Seritage...could work out very very very well or VERY bad

 

SRG is a company that Pabrai has been following for years and probably understands quite well

 

http://www.chaiwithpabrai.com/blog/my-two-cents-on-seritage-growth-properties-barrons

 

 

[Spekulatius]

https://www.sec.gov/Archives/edgar/data/1549575/000154957520000008/seritage13G.txt

 

going big into Seritage...could work out very very very well or VERY bad

 

SRG is a company that Pabrai has been following for years and probably understands quite well

 

http://www.chaiwithpabrai.com/blog/my-two-cents-on-seritage-growth-properties-barrons

 

How do you guys find these thing? I did a search for Mohnish Pabrai and the latest filing filing didn’t show. Same when I searched for SRG.

https://www.sec.gov/cgi-bin/browse-edgar?action=getcompany&CIK=0001173334&type=&dateb=&owner=include&count=40&search_text=

[Orchard]

It somehow filed with the SEC as if Dalal Street, LLC had issued it on Dalal Street, LLC. Some sort error that the issuer wasn't Seritage Growth Properties.

[investmd]

Good example.

 

Also as older disillusioned investors quit, for the scheme to continue you need new investors. The new investors have water mark set at their cost. So any accidental returns for the short time period gives the GP some money. Hence the pressure to be optimistic, constant media presence, puff pieces etc.The cycle can continue ad infinitum.

 

 

This reminds me of a comedic piece in my local language movie. There was this ace marketing guy who put posters all over the small town. It says “How to make $1,000,000 in one day?” It was an exclusive offer and entry price was $1000. Only 1000 people were selected for this offer. It was oversubscribed. The excited small town folks attended it. The pitch basically was that each person can go to a different town and make the same pitch and make $1MM.

 

Eventually you run out of towns to give this pitch.

 

You make enough and then diversify into other ventures.

 

This is a bold accusation. My understanding is that new investors come in at all time high water mark - NOT from purchase price. IF I'm correct in this understanding, would you agree that your scheme above would not be accurate?

GP doesn't get paid until they've made 6% compounded annually from all time high water mark. Thus, if someone buys in today, NAV would have to compound at 6% annually from Dec 2017 high.

[Tim Eriksen]

Good example.

 

Also as older disillusioned investors quit, for the scheme to continue you need new investors. The new investors have water mark set at their cost. So any accidental returns for the short time period gives the GP some money. Hence the pressure to be optimistic, constant media presence, puff pieces etc.The cycle can continue ad infinitum.

 

 

This reminds me of a comedic piece in my local language movie. There was this ace marketing guy who put posters all over the small town. It says “How to make $1,000,000 in one day?” It was an exclusive offer and entry price was $1000. Only 1000 people were selected for this offer. It was oversubscribed. The excited small town folks attended it. The pitch basically was that each person can go to a different town and make the same pitch and make $1MM.

 

Eventually you run out of towns to give this pitch.

 

You make enough and then diversify into other ventures.

 

This is a bold accusation. My understanding is that new investors come in at all time high water mark - NOT from purchase price. IF I'm correct in this understanding, would you agree that your scheme above would not be accurate?

GP doesn't get paid until they've made 6% compounded annually from all time high water mark. Thus, if someone buys in today, NAV would have to compound at 6% annually from Dec 2017 high.

 

Maybe some funds do it that way, but I have never seen it.  Since incentive fees are usually charged at year end, it is the year end high water mark (not all time) that matters.  Typically new investors come in at the current NAV which is that investor's high water mark.  Even new money for existing investors is blended so that once the dollar difference between current value and the high water mark for incentive fees is hit they are charged incentive fees. 

[Vish_ram]

From the article

 

“ If such investor was to move into another hedge fund, he would step into the new fund with a high watermark equal to his investment and would be subject to performance fees on those assets anyway.“

 

https://hedgefundlawblog.com/hedge-fund-performance-fees-–-is-it-time-to-rethink-the-high-watermark.html

 

Good example.

 

Also as older disillusioned investors quit, for the scheme to continue you need new investors. The new investors have water mark set at their cost. So any accidental returns for the short time period gives the GP some money. Hence the pressure to be optimistic, constant media presence, puff pieces etc.The cycle can continue ad infinitum.

 

 

This reminds me of a comedic piece in my local language movie. There was this ace marketing guy who put posters all over the small town. It says “How to make $1,000,000 in one day?” It was an exclusive offer and entry price was $1000. Only 1000 people were selected for this offer. It was oversubscribed. The excited small town folks attended it. The pitch basically was that each person can go to a different town and make the same pitch and make $1MM.

 

Eventually you run out of towns to give this pitch.

 

You make enough and then diversify into other ventures.

 

This is a bold accusation. My understanding is that new investors come in at all time high water mark - NOT from purchase price. IF I'm correct in this understanding, would you agree that your scheme above would not be accurate?

GP doesn't get paid until they've made 6% compounded annually from all time high water mark. Thus, if someone buys in today, NAV would have to compound at 6% annually from Dec 2017 high.

[indirect]

Not true for Pabrai Funds. Highwater marks are calculated at NAV and if a new investor comes at bottom as in march 2009 or any other intermediate bottom, new investor does not pay performance fees until NAV reaches high-water mark plus 6% per annum.

[investmd]

Not true for Pabrai Funds. Highwater marks are calculated at NAV and if a new investor comes at bottom as in march 2009 or any other intermediate bottom, new investor does not pay performance fees until NAV reaches high-water mark plus 6% per annum.

 

Thanks Indirect. That's what I thought, but wasn't sure. Is that piece of data strong enough to negate many of the previous comments re collecting fees?

 

NAV for one of the Pabrai Funds at end of 2019 was 35% higher than end of 2016, but 35% lower than end of 2017. So if someone were to invest today, NAV would have to be 6%/yr higher than in 2017 for manager to collect fees. Thus, theoretically even if the fund ended 2020 up 45% on the year (it's definitely not a likely event as it's currently deeply negative), no fees would be paid.

[Vish_ram]

Each investor has a unique entry point (NAV).

 

Assume that nav went from $100 to $130 by year end. Assume that a new investor Mr Unlucky joined when NAV as $150 during mid year. Will Mr Unlucky be paying perf for the 30% returns that other investors enjoyed?

 

Why shouldn't GP charge fees when GP made fees for all but say 1 investor?

[pabrai]

Pabrai Funds uses the same high water mark for all investors. This is significantly disadvantageous to the fund manager but it has never bothered me. Investors who enter well below the high water mark get a free ride for a while - in some cases for a very long while. For example after July 1, 2007, PIF2 collected no fees from any investors till 2017. 10 years. It had to get back to the 2007 high plus 6% annualized before fees were paid. After the 65+% drop from 2007-09, it took until 2017 to be in fee earning territory. I had no trouble living on fresh air and water for ten years :-).

 

There is some justification for this. When investors join the funds, for example, on April 1, 2009, they help themselves and other investors as those new funds typically do really move the needle for everyone as they are deployed around market lows. It takes a lot of intestinal fortitude to step up to the plate and put cash to work on dates like April 1, 2009.

[Munger_Disciple]

It seems that if PIF is down when a new investor joins, he benefits from having a HWM that is higher than his entry point fund NAV. However if he comes in at a NAV higher than current HWM (as in the example of Vish_ram) he will pay a higher performance allocation relative to existing investors. Is this correct?

[Tim Eriksen]

It seems that if PIF is down when a new investor joins, he benefits from having a HWM that is higher than his entry point fund NAV. However if he comes in at a NAV higher than current HWM (as in the example of Vish_ram) he will pay a higher performance allocation relative to existing investors. Is this correct?

 

From the annual report, if more than $25,000 comes into or out of the partnership, incentive fees are assessed whether or not it is the end of the year.  To be fair what they would have to do is pro-rate the 6% hurdle for a partial year and assess incentive fees if any were earned.  That way everyone is treated equally and the NAV can be the same for all.  Thus it would be impossible to come in above the HWM since the new addition would trigger assessment of incentive fees.           

[Munger_Disciple]

It seems that if PIF is down when a new investor joins, he benefits from having a HWM that is higher than his entry point fund NAV. However if he comes in at a NAV higher than current HWM (as in the example of Vish_ram) he will pay a higher performance allocation relative to existing investors. Is this correct?

 

From the annual report, if more than $25,000 comes into or out of the partnership, incentive fees are assessed whether or not it is the end of the year.  To be fair what they would have to do is pro-rate the 6% hurdle for a partial year and assess incentive fees if any were earned.  That way everyone is treated equally and the NAV can be the same for all.  Thus it would be impossible to come in above the HWM since the new addition would trigger assessment of incentive fees.           

 

That makes sense. So even if it is the middle of the year, incentive fees are assessed and are paid by the existing investors (if there is a new contribution) and this will reset the HWM to the current NAV and thus it will be the same for existing and new investors. 

 

Thanks Tim Eriksen!

[Tim Eriksen]

It is a bit weird but PIF3 has different setup than PIF2 and PIF4.  PIF3 says year end allocation while PIF2 and PIF4 have valuation dates triggered by redemptions or contributions.

[stahleyp]

Pabrai Funds uses the same high water mark for all investors. This is significantly disadvantageous to the fund manager but it has never bothered me. Investors who enter well below the high water mark get a free ride for a while - in some cases for a very long while. For example after July 1, 2007, PIF2 collected no fees from any investors till 2017. 10 years. It had to get back to the 2007 high plus 6% annualized before fees were paid. After the 65+% drop from 2007-09, it took until 2017 to be in fee earning territory. I had no trouble living on fresh air and water for ten years :-).

 

There is some justification for this. When investors join the funds, for example, on April 1, 2009, they help themselves and other investors as those new funds typically do really move the needle for everyone as they are deployed around market lows. It takes a lot of intestinal fortitude to step up to the plate and put cash to work on dates like April 1, 2009.

 

Well, there is the official answer I suppose. In my humble opinion, fair compensation plan for investors, very sketchy marketing though.

[Vish_ram]

THanks for the clarification. I was wrong about this.

 

This is indeed fair for LP’s.

 

Pabrai Funds uses the same high water mark for all investors. This is significantly disadvantageous to the fund manager but it has never bothered me. Investors who enter well below the high water mark get a free ride for a while - in some cases for a very long while. For example after July 1, 2007, PIF2 collected no fees from any investors till 2017. 10 years. It had to get back to the 2007 high plus 6% annualized before fees were paid. After the 65+% drop from 2007-09, it took until 2017 to be in fee earning territory. I had no trouble living on fresh air and water for ten years :-).

 

There is some justification for this. When investors join the funds, for example, on April 1, 2009, they help themselves and other investors as those new funds typically do really move the needle for everyone as they are deployed around market lows. It takes a lot of intestinal fortitude to step up to the plate and put cash to work on dates like April 1, 2009.