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Collection: Mohnish Pabrai - #26 'Cash Allocation'



Okay, so I just want to make sure I got the question. So you said that I hadn't invested in 17 months, and you were asking I guess why that is?

And the second is that something about cash about – you know being in cash, I didn't get that part. Well, alright so let's handle the cash question first and in fact, that's a wonderful question.

So you know in 2008 and 2009 [Inaudible] in the market. In fact, you know the indices were down, you know, 38-39% I think in 2008, we were down close to like 67% or so. We were down a lot more than the market was declined.

And well, there's a couple reasons – One of the reasons that we were down that much because we were fully invested, we were caught being flat footed. And of course, we've made up all of that ground and then some in the last few years, but I did a lot of soul searching as to why, you know, what went wrong in our process and such. And I made some adjustments.

And so I said you know, it's really important to have cash at times when market so severely distressed. You know, anything that we invested in the fourth quarter of 2008 or the first quarter of 2009 is probably a 4x or 5x of those prices until now. A very significant returns for possible at that time.

But of course, I was not able to play offense because I didn't have cash, to the extent I wanted to. So I said, how do I ensure that when we hit these serious air pockets that we have the ability to have cash?

So first of all, it's just some basic math so let's say, I have a fund that's 80% invested and 20% in cash, okay? And let's say the market dropped 50% and let's just say that my holdings also bitter the market, they also dropped 50%.

Well, what would happen is that my fund would dropped from being worth – Let's say it was worth a hundred million before, the 80 million in stocks would dropped to 40 million, on the 20 million in cash would still be worth 20 million. So a 50% market dropped would translate to a 40% market dropped for me because of the cash cushion. So the first question of cash cushion is what it do, it is likely to cushion your drop be less than the market which is useful.

The second is that, that 20% cash can now go on the offense and can get fully invested. And like I said in 2008-2009, if you had that sort of cushion there were lots and lots of opportunities to get a 4x or 5x in a few years.

So let's say you take that 20% and you invested, and you get a 4x returns in a few years. So that 20 million becomes a 80 million, the other 40 million might come back to 80 million or maybe even if it doesn't come back, let's it ends up being worth 70 million. Well, you now have a fund that's worth a 150 million you know, 50% above what it was before the crash.

And on top of that your volatility and your drop would be less than the market drop, these are all good things. So what the 2008-2009 period sear in for me is the importance of a cash cushion.

So the question was how do you know when you should have a cushion and when you should be fully invested? The way I came up with taking care of that and I said, okay if we have a brand new fund, let's say it's a 100 million in cash.

I said that the first 75 million can get invested in ideas that are a 2 to 3x in 2 to 3 years, you know, a double of it in 2 to 3 years is fine. Then the next 10%, so the first 75% was invested in 2 or 3x. The next 10%, we need at least a 3x so that would get you to 85%. Then the next 5%, I said should have at least 4x return possibility so that will get you to 90%. The last 10% is 5x or more.

Okay, so basically if I looked at my fund for almost the last 17 months, we were sitting on about 10% cash for most of this period. And so the bar was that it could get invested, if we found opportunities which were a 5x or better in 2 or 3 years with relatively muted downside. And that's a high bar, it's not easy to find 5x.

In fact, my purposes of having this talk with you today it is to impress upon you that you were put on this Earth to send me those 5x. And so, you know Arvind will give you my email address, but it's also at the end of that video. And so when you have those 5x ideas after you have fully satisfied your own appetite, you can send it to me and that will be much appreciated.

And so basically, what that – you know, first 75% 2x then 3x, 4x and 5x does, it acts like a circuit breaker. It prohibits me from basically getting fully invested. Unless either market get distress or some very compelling ideas show up.

And so, you know, we've been floating around for the last year and a half or so with that cash cushion. And in fact, I see nothing wrong with that 10% or 15% cash cushion, even 20% cash cushion being almost permanent, you know, that's perfectly fine.

I think that the idea that markets would go dislocation is almost 100%, we will see plenty of dislocations, you will see several dislocations in your lifetime. And so the dislocation will happen, we don't know when they'll happen and quite frankly to get fully invested, you don't even need dislocations. You might get fully invested with some anomaly with particular businesses in particular Industries going through temporary distress. And that's perfectly fine too, so that's the reason why.

We found a lot of 2x or even 3x but they were not enough to – you know, pull the trigger if you will. And that's why we're sitting on with the cushion that we are sitting on.



[YAPSS Takeaway]

How would Mohnish Pabrai allocate capital if he is starting a new fund? (2013)

- 1st, 75% of capital; in 2x to 3x return stocks.

- 2nd, 10% of capital; in at least 3x return stocks.

- 3rd, 5% of capital; in at least 4x return stocks.

- 4th, 10% of capital; in 5x or more return stocks.

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