What if I told you that one of the best investors in the world just released a new type of portfolio that not only beats the market, but beat the S&P 500 by a staggering 10.7% during one of the worst 16 year periods in market history. And I’m not talking about the total return amount either, it beat the market by 10.7% every year on average. If we look at the total or cumulative return, it beat the S&P by a whopping 953.8%. Do I have your attention yet?
Not only am I going to show you how this portfolio is made. I’m also going to show you how you can do this too, and what businesses this portfolio owns this year. The best part is, he’s giving it to us, no strings attached.
Our Hero
The Investor who just released this Portfolio is one of my favorites of all time. His name is Mohnish Pabrai. Author of my favorite investing book The Dhandho Investor: The Low-Risk Value Method to High Returns. In this book he discusses a topic that I’ve recently been putting into my own investing practice; Cloning. No this doesn’t involve sheep or anything like that. What it does involve are the best investors in the world, and they tell us what companies they are buying, selling, and some resources tell us the price they paid. Let me explain…
13 is our lucky number
It’s called a 13F, and it works like this. Any investor with $100 million or more invested in the US equity markets, must disclose everything they have bought or sold within 45 days of the Quarter-end. They must do this. It’s the law. And it’s to our great benefit, because this information is public. Yup, we as the average investor have the opportunity to see what the best investors in the world have recently bought and sold, all for free. How you ask? Well, I wrote an article about one of my favorite ways to do so, which is through a site called Gurufocus. In this article I explain how I use it, and why it works (I also mention a couple other ways to do so at the bottom of the post). Basically, you find an investor you really like (a Guru), then you can search and find what they have bought and sold every quarter. Here’s How Pabrai puts it; ‘Santa knocks on all our doors not once, but four times a year. During his off-season, he reliably shows up bearing profitable gifts on February 14th, May 15th, August 14th and November 14th. These are the deadlines for 13-F filings with the SEC’.
These sites make it much easier for us to track some of the best investors in the world. GuruFocus for example, not only shows you what companies they bought or sold, but they also show The Price They Paid. This means that you can check the current stock price against that price, and sometimes, the stock is trading lower than what the Guru paid for it. Pretty neat, right? As Pabrai says, when it comes to investing, ‘There is such a thing as a free lunch’. And personally, I think this one sounds delicious.
The Skeptics
I know some of you efficient market theorists will complain that with the multi-month delays, buying the companies that the Guru’s buy just won't work. The delay is too big, and the markets are too efficient. Well it turns out, that’s not true at all. But, don’t just take my word for it. On April 15, 2008, a study by Professor Gerald Martin and John Puthenpurackal was conducted on this very thesis. They called the study, Imitation is the Sincerest Form of Flattery. What they did was cloned Berkshire Hathaway’s equity portfolio from 1976 to 2006. They did this by buying the same positions the company did, but with a substantial delay. This cloned portfolio bought (and/or sold) at the beginning of the next month that this information went public. In other words, if this information was disclosed on February 14th (for example), this study would have bought on the first trading day in march. The methodology in a study is important, but what’s more important, are the findings.
How well does cloning work?
Maybe that's not the right question. Maybe a better question would be: ‘How much does cloning have to beat the market by before you’d try it?’ 3%? 5%? 8%? Keep in mind, that any long-term fund manager who can beat the market by 3% over any long period of time becomes Extremely Popular. So, seriously. Take a second, and ask yourself this question: What would it honestly take?
I’ll let you mull that one over while we answer the question in the heading…(How well does cloning work). Answer: Extremely well. When you choose the right person (or people) to clone. Martin and Puthenpurackal found that their portfolio absolutely demolished the stock market, beating it by 10.75% per year over a 30 year period. In other words. This cloning thing will really work for us.
The ‘Shameless Cloning’ portfolio
We know that cloning Warren Buffett’s, Berkshire Hathaway has worked in the past, but now they are huge. With a market cap of around $400 Billion, It will some big purchases, and big wins to make that $400 billion grow at the same rate as it has in the past, and due to the law of large numbers, that’s just not likely. Luckily for us, Pabrai has taken care of this part for us. He’s been in the industry for over 18 years, and has hand picked a group of 9 value investors that perfectly fit into the archetype we’re looking for (Including himself). In other words, these managers have used value style investing to crush the market over long periods of time, and Pabrai thinks they are poised to continue to do so into the future.
The Managers
Here’s the list Pabrai came up with (in alphabetical order).
How does this portfolio get its picks?
This idea, Mohnish says, was inspired by the ‘Small Dogs of the Dow’ strategy which buys the 5 lowest priced stocks out of the ‘Dogs of the Dow’ that you’ve likely heard of before (you can read more about it here). This is where Pabrai’s portfolio comes in. He and Fei Li (the Quantitative Analyst that works with him) created what they call the ‘Shamelessly Cloned Portfolio’. Like the dogs of the Dow, it only uses 5 picks, the difference is, it uses the highest conviction picks of the amazing managers listed above. And like the Dogs of the Dow, you buy at the beginning of the year, and do nothing until next year. Just set it, and forget it. To me, it sounds like an amazing passive investing strategy.
You can have your Pi and eat it too...
This is where we go into the weeds a little bit here. Fei is known as an incredibly talented Quant. She wrote the code for this algorithm after her and Pabrai came up with this idea. They then decided to use the mathematical constant Pi (as in 3.14159265….), to eliminate human bias when making the stock selections. Because Pi has an infinite stream of numbers, they can rely on it each year for the picks. See how each fund manager above has a number assigned to them? Well, each number corresponds to that number in Pi. This means that the first digit after the decimal point represents Appaloosa Management (Manager #1). Their algorithm then picks the highest conviction bet in that portfolio and moves onto the next number (4) and next corresponding manager (Greenlight Capital), until it has 5 different high conviction choices. This algorithm also avoids certain areas of the market, such as REITs, utilities, and any unprofitable businesses.
Note: If a holding has already been selected through a different manager, the algorithm will look at the second highest conviction of that fund manager. In other words, it won’t allow the same company to be picked twice. Similarly, if the manager’s highest conviction idea is in a blocked industry (REIT, Utility, etc.) it will look at the second highest conviction idea of that manager before moving onto the next. This happens until 5 different ideas are selected. The last number that was used in the Pi sequence is the starting place for next years picks, and so on.
Since the beginning
Pabrai and Fei Li went back to the year 2000 to test the validity of their algorithm, but they also stopped there because that’s when the most managers in the portfolio, were filing 13F’s (otherwise there was no way to track them). At inception however, portfolio managers 2, 6, 8, and 9 never filed a 13F. So, the selection for the first year looked like this:
3.1415926535897… = Fund managers 1,4,5,3,7.
The second year picks were…
3.1415926535897932384626433832795028841…
Third year picks were… You know what, nevermind, you get it.
This was done right up to this year (2017).
Shameless Vs Index funds
Many ETF investors use the S&P to invest in the overall market, and for many, this is a great way to invest, as long as they keep adding more money over time, and basically dollar cost average into the Index. This will give you market average results, meaning you will do as well as the other average investors who could keep holding though large downturns in the market. But, if you are able to fight the urge to sell, if you start early enough in life, and save much more than you spend, you will get rich this way. It’s almost an inevitability.
For those who want to do better than the average, Pabrai freely and generously gives us a way. I already mentioned how well the Shameless Portfolio performed, but let’s look at a chart now, comparing the Shameless Portfolio to the S&P and the Small Dogs of the Dow to see how it stacks up.
As you can see above, the Shameless Portfolio was the definite best choice of the three. Of the 16 years, the Shameless Portfolio managed to outperform the S&P 14 of those 16 years. The Portfolio only had 1 negative year (vs the S&P’s 4 negative years) and had an annualized return of 15.5%, well above the 4.8% the S&P managed. Most will say that the average return of the market is between 9-10%, and that’s true. However, there are always periods like this one, where your money will grow much slower (only 4.8% per year), and a re-evaluation of our investing practice is needed.
The problem with Buying the market
As proven above, buying the overall market may not be your best choice. Maybe instead of following the pundit of diversifying for less market risk you should realise that there is no such thing. Diversification quickly turns into over-diversification leading the investor to sub-optimal returns (4.8%), while still ‘enjoying’ the large downswings in the market. Remember, If the market falls, it takes everything down with it, no matter how well it’s diversified. As they say, small ships are lifted with the tide, so to do they fall. If you only invest in ETF’s, your best hopes are to be average. And even then, that’s only if you can handle the big 30-50% drops that will occur numerous times in your lifetime. The other chance is a return period that is much less than the average (like the 4.8% above). Many people are depending on that 9% return to reach their retirement goals, and 4.8% just won’t cut it.
The Shameless Picks from 2000 - 2017
Shameless Portfolio picks for 2017
Here’s what you’ve been waiting for. This years picks for the Shameless portfolio. To follow the rules, you should allot an equal amount to each holding (as best as you can). Then you rebalance every year, closest or after January 1st.
Oracle
Berkshire Hathaway
Apple
Microsoft
Charter communications
Tax Note: To optimize this portfolio for tax purposes, sell your winners after 366 days, and your losers on or before the 364th day.
Here’s the best part
This algorithm picks the new stocks on December 31st of each year. Even though we’re a couple months into the year, Pabrai says you can buy enter the portfolio at any time. And as far as compounding your money goes; the sooner, the better.
Note: In order for you to get the benefits that the Shameless Portfolio gives, you have to follow the rules. This means, you don’t sell until the end of the year, and follow the program for as many years as you can. It will be tempting to sell early, or to buy more. Therefore, I implore you to just follow the rules. This is a set it, and forget it type of portfolio, and it will work best for you if you treat it that way.
Shameless Portfolio Rules (from Pabrai’s website)
The Algorithm:
1. Will not pick Utilities, REITs, oil and gas exploration, metal or mining, or multi-line retailers.
2. The company the algorithm picks must have a positive trailing-12-month net income.
When to buy, and sell
New information is released for us on December 31st of each year.
Winners you sell after 366 days, losers you sell on or before 364th day.
The money from selling is divided equally into the 5 companies the portfolio displays and are on Jan 1st or right after.
The same company can show up for a second year in a row. If this happens you leave it unchanged, and use the remaining balance to equally buy the four remaining companies.
If the business pays a dividend, you reinvest that money into the company that paid it.
If there is an involuntary removal through acquisition/delisting/bankruptcy, then the cash is distributed equally among the remaining companies.
If there are any spin-offs, the shares are sold and reinvested in the parent company.
Disclaimer:
Note, anyone who invests in any strategy needs to do their own research/due diligence and are themselves fully responsible for the outcome.
Chai with Pabrai
This is Mohnish Pabrai’s new blog. You should add it to your favorites. Not only does he post interesting information, but this will be the place to get the new picks each year! (I’ll also post them here and send them to my email list.
Summary
So here’s my point. Consider adding the Shameless portfolio to your own, it likely has a place in everyone's portfolio (especially if it continues to beat the market by 10.7%). Also keep learning and growing as an investor. If I hadn’t continued to read, and learn more about investing, I never would have bought Pabrai’s Awesome book (The Dhandho Investor: The Low-Risk Value Method to High Returns), And therefore, would have never continued to follow his work, allowing me to learn about his ‘Shameless Portfolio’.
You never know where your investing Journey will take you. But I promise that if you start, you’ll end up in a better place then if you never started at all. And I’ll be here with you, continuing to learn as much as I can, and passing on what I learn to you.
Thanks for reading!
We’ll talk again soon
~Ryan Chudyk~
PS.
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