January 26, 2009
Few more articles about investors using gold as a potential inflation hedge.
Our current chairman of the Federal Reserve, Ben Bernanke, is an “inflationist.” When times were good, he supported an easy money policy. Even when the Fed raised rates, Bernanke took great pains to give the markets many warnings to insure that the higher rates wouldn’t break up the credit party, i.e. bubble formation. Now that the cycle has turned, the Fed has promised to resort to “all means necessary” to head off the effects of the collapsed bubble. Rates have effectively been lowered to zero. The Fed is making loans collateralized by toxic waste and has now begun a policy called “quantitative easing” — a fancy term for “printing money.” The size of the Fed’s balance sheet is exploding and the currency is being debased. Combined with an aggressive fiscal policy, it is clear that the authorities are going “all-in” to try to mitigate the near-term effects of the economic collapse. Our guess is that if the chairman of the Fed is determined to debase the currency, he will succeed. Our instinct is that gold will do well either way: deflation will lead to further steps to debase the currency, while inflation speaks for itself. We have bought gold, calls on gold, an index of gold mining stocks (GDX) and calls on higher long-term U.S. interest rates. We have also moved some of our cash into foreign currencies, particularly the Japanese Yen.
Pabrai Funds is primarily a stock picking outfit. We know very little about bonds or fixed income. Thus we should be the last ones to pontificate on bonds and US Treasuries. The reason I have ventured out and commented is because the situation is so extreme today. On one hand, yields on US Treasuries are the lowest in decades. On the other hand, yields on every other kind of debt are at their highest levels (relative to treasuries) in decades.
Municipal bonds are among the safest investment class out there – especially when bought as a basket. With their tax-free nature, they typically yield less than treasuries (which are taxable). Today 30-year munis have yields that are 161 percent higher than 30-year T-Bills. It is unprecedented.
Typically the yield delta between 10-year treasuries and Baa rated corporate bond has vacillated between 10 and 400 basis points (0.1% to 4%) for over 45 years – with the average being around 200 basis points (2%). It got over 300 basis points in just 6 of the last 45 years – and quickly fell back to the 2% level. In December, 2008, this delta hit 616 basis points – 6.2%! While 10-year treasuries yielded 2%, the Baa corporate bonds yielded over 8% – the widest spread in over half a century.
I believe these spreads between US Treasuries and various types of bonds will get back to historical ranges in the not too distant future. They may even overshoot (very tight spreads).
How can I setup Pabrai Funds to protect and profit from the above? Well, the best assets to own in an inflationary world are businesses whose products are inflation indexed – where prices can be raised at or above the rate of inflation. In addition if a business has done large amounts of capex using old dollars and does not have much need for capex at new dollars, yet can sell products at inflated prices, it is likely a home run. Such a business has a minimal need to take on additional debt. It is a beneficiary of both high interest rates and high inflation.
April 16, 2008
Few highlights from Berkshire Hathaway’s 2007 annual report.
Charlie and I look for companies that have:
- a business we understand
- favorable long-term economics
- able and trustworthy management; and
- a sensible price tag.
A truly great business must have an enduring “moat” that protects excellent returns on invested capital.
But if a business requires a superstar to produce great results, the business itself cannot be deemed great.
There’s no rule that you have to invest money where you’ve earned it. Indeed, it’s often a mistake to do so.
[Talking about investments in different types of companies] To sum up, think of three types of “savings accounts.” The great one pays an extraordinarily high interest rate that will rise as the years pass. The good one pays an attractive rate of interest that will be earned also on deposits that are added. Finally, the gruesome account both pays an inadequate interest rate and requires you to keep adding money at those disappointing returns.
[On buying Dexter, a shoe business with Berkshire stock] In essence, I gave away 1.6% of a wonderful business – one now valued at $220 billion – to buy a worthless business.
[On buying Amazon bonds at 57% of par] Yes, Virginia, you can occasionally find markets that are ridiculously inefficient – or at least you can find them anywhere except at the finance departments of some leading business schools.
September 12, 2007
Value Investing News highlighted this presentation (pdf) from Centaur Capital Partners about how concentrated an investment portfolio should be.
A few quotes from the presentation:
Not every idea has to be worthy of a very large position allocation to be included in our portfolio so long as each idea adds an unique element that contributes something to the favourable asymmetric payoff profile for the portfolio as a whole.
Value comes in many forms, including:
- Out-of-favor blue chips
- Out-of-favor cyclicals
- Distressed industries
- Discounts to cash
- Declining cash cows
- Overlooked small caps
- Oddball companies
- Fallen growth angels
- GARP (growth at reasonable price)
- Activist opportunities
There are several common “portfolio models” used by successful value investors that we have come across:
- Ultra-concentrated portfolio model
- Fewer than 10 stocks with large position sizes routinely comprising 20-25% of portfolio assets and larger.
- Practitioners: Chieftain, Eddie Lampert, Tom Brown.
- The 10 stock model
- Standard position size of around 10%, though there may be one or two larger positions, and a handful of smaller positions for a total of 12-20 ideas.
- Practitioners: Mohnish Pabrai, Clipper.
- Standard 20-stock model
- Standard position size for a good idea is about 5%, though best 2-3 ideas may be modestly larger and many ideas are somewhat smaller. Total portfolio of 25-40 ideas.
- Practitioners: Many of the value mutual fund managers on the previous slide: Robert Hagstrom, Bill Miller, Wally Weitz, Longleaf Partner, Tweedy Brown Value, etc.
- 20-stock model (super-sized)
- Essentially the same as standard 20-stock model, but two or three best ideas are “super-sized” to 10-15% of the portfolio, and there are fewer sub-5% positions. Total of 20-30 ideas.
- Practitioners: Tilson Focus, Fairholme, Sequoia, Oakmark Select.
“Confronted with the challenge to distil the secret of sound investment into three words, we venture the motto, MARGIN OF SAFETY.” Benjamin Graham, Intelligent Investor.
Why is having a margin of safety important?
- Valuation is an imprecise art.
- The future is inherently unpredictable.
- Having a margin of safety provides protection against bad luck, bad timing, or error in judgment.
September 5, 2007
Value Investing News has a link to Whitney Tilson’s 2007 Wesco annual meeting notes (pdf). They make for good reading. Charile Munger is Chairman of Wesco.
Some selected quotes from the meeting are below:
If you really want a lot of wisdom, it’s better to concentrate decisions and process in one person.
I talked to a leading person in the accounting field and said it didn’t make sense to let companies mark weird stuff to their own models – that it would lead to disaster. She looked at me like I was out of my mind and asked, “Aren’t you for the most current data in accounting? My system is more current and therefore should be better.” This mind would score highly on an IQ test, but is scarcely able to throw out the garbage.
If you’re really wise and fortunate, you get to be like Berkshire. We have high opportunity costs. We always have something we like and can buy more of, so that’s what we compare everything to.
September 4, 2007
The FT has an article about how cheap financial shares are at the moment. Which reminded me about Ariel Funds recent letter to investors, in which they outline why UBS is a good investment.
Ariel Funds estimates UBS’ intrinsic value to be US$94 compared to their purchase price of US$60 and today’s price of US$52.
You can check out more of John Roger’s (founder of Ariel Funds) current investments on Gurufocus.
July 27, 2007
I have finished reading Joel Greenblatt‘s book – You Can Be a Stock Market Genius: Uncover the Secret Hiding Places of Stock Market Profits. Which I highly recommend.
The main points I got out of the book are:
- Spin-offs are an attractive area to invest in. Investors that receive shares in a spin-off normally do not want to hold them and sell soon after the spin-off. For example an institutional investor may not even be allowed to hold shares below a certain market cap or outside of the S&P500.
- Look for institutional investors that do not want the shares and will sell them immediately, depressing the price.
- Insiders want to buy the shares, look for management making an investment.
- The transaction may unlock hidden value, the business may be able to operate more efficiently after being spun-off from the parent company.
- Holding companies can offer good opportunities. For example a company that holds some listed shares, might trade at a discount. Or at the same value, letting you buy the core business for close to zero.
- Merger securities. Can offer investment opportunities for the same reason as spin-offs. The people receiving the securities do not want them, so look to sell them straight away. Plus always look at the details in the SEC filings.
- Companies coming out of bankruptcy. These may not be looked at by other investors due to lack of coverage or unwillingness to invest in a company that has been bankrupt.
- LEAP options can offer extra upside for investments.
- Options can be useful when investing in spin-off opportunities. Any option that can be exercised after the spin-off entitles the holder to receive a share in both the parent and the spin-off.
- Steal other people’s ideas. Read investment newsletters, read other investors’ annual reports and announcements.
The book has a number of case studies which are useful in understanding each of the concepts and showing that they really do work (or have worked in the past).
June 12, 2007
Summary of Ben Graham’s principles from Oak Value shareholder letter (pdf).
- Investing is most intelligent when it is business-like. Very simply, we view this principle as suggesting that one should view investments in public companies in the same manner that they could if they were going to buy the entire business.
- Always require a “margin of safety”. We define “margin of safety” as a discount to our
estimate of a company’s intrinsic value sufficient to compensate us as investors for the risks and uncertainties assumed and the capital allocated.
- Maintain the appropriate perspective. Recognize that the market is a mechanism; a vehicle there to facilitate what we might wish to do as investors, but it does not require that we do anything.