‘Specifically, the more time we spend analysing a given business, the more likely we are to like it and invest in it. But if we don’t spend time studying a business, how are we expected to understand its prospects and likely future? This strong commitment bias is an important reason why most investment managers have trouble beating the index,” Pabrai, Managing Partner of the US-based Pabrai Investment Funds, said in a presentation at the Talk @, whose video is currently available on.
Why Best Ideas Fund didn’t workGiving the example of Capital Group’s Best Ideas Fund, Pabrai says it failed to outperform the benchmarks even though it included the stock picks of best portfolio managers. Best Ideas Fund was simply the stock picks on which portfolio managers had spent most time on and were most excited about.
“This happened because the human mind functions like the human egg and suffers from commitment and consistency bias. Once the first idea gets in, just like the human egg, it locks up and seals off any additional ideas from coming in. This is also often seen in political discourse, where we are not open to hearing the opposite point of view,” says he.
‘If you talk to the folks who love, they can’t see anything wrong with him. If you talk to the folks who are on the other side, they can’t see anything right with him. And then, of course, reality probably is some shade of gray in the middle there,” said the veteran money manager.
Pabrai feels another reason why Capital Group’s Best Ideas Fund didn’t do well was that the portfolio managers were specialised in specific industries and were biased towards suggesting the best companies of those particular industries. “To build a successful portfolio and amass great wealth, investors need to spot the best stock, and not the best company, of a particular industry,” he said.
‘Some portfolio managers specialise in utilities, another specialises in coal industry and someone else inand so on. If you go to the guy who’s focused on the coal industry, he’s probably going to give you the highest conviction coal idea that he has. And what you want in the portfolio is not the best coal company, but the best stocks. So, there’s a kind of siloed approach to people having specialisations can lead to. Utilities, for example, could all be overvalued at a particular point in time. So you bring in a utility, you bring in a coal stock, and so on and so forth, and obviously the end result isn’t going to be so good,’ he says.
3 hacks to overcome these biases
Pabrai says it is important to counter these biases and build a framework which can help get around some of these issues as it is essential to spend time studying companies before making investment that can itself lead to one becoming biased.
Pabrai comes up with 3 hacks to overcome this dilemma:-
· Be aware and let rationality prevail
Just being aware of the fact that we have a lot of biases and our mind can play games and tricks on us is a huge advantage, which can help us be rational in different situations. ‘A very useful approach is to be fluent on the other side of the argument. If you are going to go long on stock, it probably is a very good exercise to spend time developing a thesis on why to go short. And that will force your brain to think about things that normally it doesn’t want to think about,’ says he.
· Say no quickly
Pabrai says it is essential for investors to stop pondering and learn to say no quickly, as the built-in bias of our mind can play games with us due to which once we spend time on something, we get pregnant with the idea. Pabrai says investing is a very forgiving business from the perspective that investors do not really need to know everything about everything.
Investors do not need to act on everything and can miss out on a lot of information and can still become successful. The advantage to just say ‘no’ fast is that it frees up a lot of time.
‘Don’t spend a lot of time while you are rushing through a lot of stuff and spend time only on the stuff that is looking like an absolute no-brainer. One of the things about the investing business is that we can let hundreds and thousands of ideas go by, and it doesn’t matter. So it doesn’t matter if we miss something that goes up 10 times or a 100 times or a 1,000 times. What matters is what we actually invest in,” says he.
· In quest for investment, be unreasonable
Pabrai says some investment decisions may seem unreasonable at a particular juncture due to the prevailing market conditions. But if investors know enough about the business and can estimate their actual worth, then they should not hesitate to invest and make a quick investment decision before certain biases set in.
Giving Buffett’s example, Pabrai explained how Berkshire bought Dairy Queen, a privately-held company, within half an hour of Buffett receiving a cold call from a banker who suggested to him that the company was available for sale and met their acquisition criteria.
‘There was no waycould have looked at Dairy Queen before, because it’s not a public stock. But he knew enough about the business to understand that basically franchise restaurants, there’s a certain way you can look at them, and you can figure out kind of what they are worth and what you want to be paying for them, and so on and so forth. And he went through that math really quickly,’ he says.
Pabrai further says quick decision making can benefit investors in the long run, as markets can get euphoric or get pessimistic any time during the same year. This market behaviour leads to distortion and mispricing which investors can take advantage of.
‘There are over 100,000 publicly-traded stocks on the planet, there are always things going on with different companies. They may get into distress or high growth and may have wide swings. Markets have this nuance where they either get euphoric or get pessimistic, and they might do both in the same year. That’s what leads to price distortions, mispricing and that’s what we can take advantage of,’ says he.
(Disclaimer: This article is based on Mohnish Pabrai’s presentation at the Talk @ Google whose video is available on YouTube)