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Professional fund managers struggle to beat the market. According to the Credit Suisse hedge fund index, hedge funds have underperformed the market by roughly 3 percent per year since 1993. That performance might seem embarrassing, but hedge funds are not as awful as they seem. Investors in hedge funds consist of wealthy individuals that want capital preservation rather than aggressive growth. But this video is not about the complex strategies that some hedge funds use. This video is about an interesting, simple, and underrated strategy that has outperformed the stock market and will likely continue to do so in the future.
Mohnish Pabrai is an investor that many of you do not know about. Despite his lack of popularity among retail investors, his investing track record manifests a unique skillset of adapting to different market environments. If someone invested $100,000 in Mohnish’s fund in July 1999, they would have $1.8 million by March 2018. That is an 18X return in 19 years, much higher than the S&P’s return of 3.3X over the same time frame. So how did Mohnish do this and what is his investing strategy? There are two strategies that long-term investors like Mohnish have used to generate enormous returns. The first strategy is to invest in growing pies. These growing pies are businesses with solid fundamentals, are trading at a reasonable price, and have the potential to grow for years to come. In other words, these are companies that you can purchase and forget about them. If you hold growing pies for a long time, you can achieve 10 to 100X returns when you choose correctly. The second strategy is to invest in discounted pies. Discounted pies are stocks that are trading on major discounts. The goal with discounted pies is to purchase stocks under their intrinsic value and sell those stocks when they exceed that intrinsic value. This was the strategy popularized by Benjamin Graham, Warren Buffett’s mentor and the author of the renowned book called The Intelligent Investor. The problem with this strategy is that you have to constantly buy and sell stocks, which is very tax-inefficient and time-consuming. Not only that, but it’s also difficult to achieve extremely high returns because your performance is usually capped by the difference in a stock’s current value and intrinsic value. So even if you do manage to purchase discounted pies effectively, your returns would be limited. There’s one more strategy that investors have used to beat the market, which is to invest in art. That might sound crazy, but wealthy fund managers often purchase art as a way to diversify their portfolio. From 1995 to 2020, contemporary art experienced an average annual return of 14% per year, much higher than the S&P’s annualized return of 9.5% per year. Retail investors like you and me can invest in art by using the sponsor of this video, Masterworks. Masterworks is a platform where retail investors can purchase shares of expensive art. The company purchases high-priced art and makes it accessible for all retail investors in the form of shares, just like the stock market. Masterworks has securitized over $200 million worth of paintings, and has over 60 total offerings. If you’re interested in investing in multi-million dollar art for a fraction of the price, check out my link to Masterworks down below. Now, let’s get back to the video. From the period of 1994 to 2000, Mohnish used the growing pie strategy to achieve high returns as an individual investor. By mid-1999, Mohnish already had some of his growing pies become 200 baggers, which is when a stock increased by 200 times in value. He realized that the party was going to end soon, and switched his strategy to buying discounted pies.
The 18X return that Mohnish achieved from 1999 to 2018 was mostly from investing discounted pies, which worked incredibly well for Mohnish. But even though an 18X return is outstanding, Mohnish recently realized that he needs to change his strategy.