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Mohnish Pabrai on Patience, Advice from Buffett, and What Ever Happened to Rick Guerin?

I just came across an interview that the Motley Fool did with Mohnish Pabrai earlier this month. Pabrai is one of my favorite investors to learn from. He is very smart, but he uses simple strategies, simple logic, and common sense ideas, which are main objectives of mine here at Base Hit Investing.

Pabrai is well known for being the winning bidder for a charity auction where the winner got to have lunch with Warren Buffett. In this short interview with The Motley Fool, he was asked to describe something he learned from Buffett that might not be common knowledge in the public domain.

Pabrai answered the question by using an example. Pabrai said Buffett answers every question in a manner that turns the question into a mini learning lesson. This particular lesson was on patience. Pabrai asked Buffett about Rick Guerin, specifically “What ever happened to Rick Guerin”?

For those who don’t know, Guerin was a very successful investor who was friends with Buffett and Munger. He is not well known. If not for Buffett and his mention of Guerin in The Superinvestors of Graham and Doddsville, we might have never heard of him at all. But Guerin’s track record (in terms of absolute performance) was actually as good or better than any of the other investors Buffett mentioned (including Buffett himself). Guerin produced eye-popping gross annual returns of 32.9% per year.

Rick Guerin Performance

So Buffett answered the question: “What happened to Rick?” by basically saying that Rick wanted to get rich too fast. Buffett and Munger always knew they were going to be rich-very rich… and because of this, they weren’t in a hurry. They knew as long as they were patient and didn’t make huge mistakes, they were going to be very rich over time. Why? Because they knew value investing had an inherent edge in the market. And because they understood that “even a slightly above average investor who spends less than he earns can’t help but become wealthy over time”.

So Pabrai said that the problem for Rick Guerin (according to Buffett) was that Rick wanted to get rich too quickly and used margin to excessively leverage his funds. He implied that Rick took significant personal hits in the 1973-1974 bear market because of his leveraged positions.

Now, when I heard this in the interview I went to the Superinvestor piece that Buffett gave in 1984 and looked up Guerin’s results. Sure enough, the ’73-’74 period was nasty for Guerin, going down around 62% cumulatively in those two years. But, it doesn’t look like that was the end for Rick. He made 31% in 1975 and 127% in 1976, followed by 4 more years of 25%+ returns.

So he did in fact take a large hit in ’73-74, but he made it back and then some. His returns were very volatile. He had 4 years of triple digit returns to go along with the nasty 62% drawdown. It looks to me like he took a value investing strategy and just levered it up to produce even better returns. It looks like it worked (overall) from 1965-1984.

But my question would be the same as Pabrai’s: What happened to him after the Graham and Doddsville track record? Did too much margin end up costing him even more severely? I’m not sure…

But the lesson that Pabrai took away from Buffett is this: Patience (and lack of debt) along with value investing will create huge wealth over time. Don’t be in a hurry to get rich. Don’t use margin, or at least use it sparingly.

As Buffett has said many times, there are only two rules of investing:

  1. Don’t Lose Money
  2. Don’t Forget Rule #1.

I hope for Rick Guerin’s sake that he continued to have much investing success even after the 1984 time period. If anyone has any thoughts or updates on Rick’s performance, feel free to share them. Below is the 5 minute interview with Pabrai.

 

10 thoughts on “Mohnish Pabrai on Patience, Advice from Buffett, and What Ever Happened to Rick Guerin?

  1. Small correction – a decline of 42.1% and another decline of 34.4% is a cumulative decline of 62% and not 75%, which is a huge difference.

    From 75% decline you need 300% return to break even, from 62% you need “only” 163% to break even, a world of difference.

    (1-0.421)*(1-0.344) – 1

    1. Another thing – Munger’s fund declined in 1973 31.5% and in 1974 31.9%. Buffett liquidated his partnerships at 1969 so he was lucky he did not get to 1973, I guess he’d show horrendous returns as well.

      As I see it: 73-74: Rick: -62%, Munger -53.3%. Not a huge difference.

      Moreover if you measure Rick’s returns since he started the partnership till the bottom in 1974 he still beat the S&P handily and by a large margin.

      I am against excessive leverage, but I think the presentation in this case is not “it-is-so-obvious-buffett-is-king” kind of thing.

      Moreover, Buffett is leveraged. Insurance business is leveraged in nature and also WFC which is WEB most loved investment is very leveraged. Munger said once that leveraging up to 20% is conservative enough, so this is one of the rare times in which I take Buffett (and Monish) with a grain of salt.

      1. Hi Assaf, thanks for the comments. Yes, I corrected the drawdown math, and you’re right… it’s remarkable how big a difference it is from 62% to 75%, although the difference is also quite large between Munger’s drawdown and Guerin’s, although it gets exponentially larger the bigger it goes of course.

        Interesting comments on Buffett… although he did liquidate the partnership, he still operated Berkshire, and although it’s not an apples to apples comparison, Berkshire’s book value actually rose 4.7% and 5.5% in ’73 and ’74 respectively.

        Obviously his partnership would have been different, but I don’t necessarily think his results would have mirrored Munger’s and Guerin’s.

        And yes, Buffett employs leverage… I believe over time his leverage has been about 1.6 to 1. As you know, insurance and banking have inherent leverage, and Buffett has masterfully used that to his advantage. However, he didn’t use much leverage at all when operating his partnerships (only a very modest amount in occasional arbitrage investments). Munger actually used significant leverage at one point in his partnerships very early on. I think I read in Schroeder’s book that he leveraged as much as 2 to 1 on a Canadian merger, with nearly all of his assets in one position. And Munger was very concentrated throughout his partnership, hence his more volatile results.

        But I think you bring up a good point… although Buffett (according to Pabrai) indicated that Guerin failed because of leverage, his actual results don’t seem to indicate that as he did very well overall, and after the 1973-74 debacle. One anecdote: I read somewhere that Guerin had numerous margin calls and was forced to sell Berkshire stock to Buffett at significantly undervalued prices, so that episode might have framed Buffett’s opinion in that case.

        In any event, I think the lesson is a good one, which is to be careful with leverage (I don’t use it at all). But I think you’re right about taking it with a grain of salt: Buffett uses leverage and uses derivatives, although he advises against the use of both in his discussions with everyday investors. His advice is probably still good, despite his seemingly contradictory behavior.

        It’s probably a “do as I say, not as I do” thing for him.

        1. Yes, BRK’s book value did increase those years, but the share price declined over 50%.
          The bad performance for Munger and Guerin is mostly becase of the decline in Blue Chip Stamps, according to “Damn Right!”. BRK along with Guerin and Munger controlled BSS, it is actually a nice story (at the end of 1974 Munger held 61% of his fund in BSS and New America Fund, both declined spectacularly). But fortunately for Buffett, he reports book value – a measurement that ignores market prices, Munger and Guerin are marking to market. So if you take BRK share price as comparable to both of them, they weren’t so far from each other. Buffett held so much of BSS that he used the equity method and not mark to market, so it is a fact he was lucky, not a guess.

          After this even Munger stopped managing money for others:
          “…But he now found that reported, temporary quotational losses in the Wheeler, Munger limited partnership account gave him tremendous pain. And so by the end of 1974, he had resolved, like Buffett, to stop managing money for others in a limited partnership format. He would liquidate Wheeler, Munger after its asset value made a substantial recovery…” (P. 106)

          It is not surprising they declined together – they were good friends and their funds invested in similar stocks and in a similar fashion, so mocking Rick here and using him as a patsy seems wrong. Its like saying: “Haha, he’s the sucker that went on and continued to manage other people’s money instead of being smart like us and moving to a company and BV measurement structure. Stupid him!”

          1. Interesting… yeah I’ve read similar accounts at how horrified Munger was at having to report substantial unrealized losses, which is interesting because they didn’t bother him personally (with his own money). Shows how difficult emotionally it is to manage capital, and how great a role that behavior plays.

            As for Rick, I don’t think Pabrai/Buffett were mocking him. I think Buffett was simply using the margin calls (the fact Rick was forced to sell BRK stock at a significantly undervalued price) as a reason to not use leverage in stock portfolios.

            But as I say in the post, Guerin seems to have gone on to do quite well after ’73-’74, and as an entire body of work, it seemed to work out for him.

            But I tend to believe that avoiding leverage at the portfolio level is a good way to manage risk, and survive the downturns.

  2. I think one crucial difference most people probably have missed on Buffett’s own derivative play is that he specifically negotiated for zero no upfront collaterals posted and zero margin calls ever for the CDS and basket index puts! He knows perfectly well how margin call can hurt at the most inopportune time. Others don’t have this kind of luxury.

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