“I believe in the discipline of mastering the best that other people have ever figured out. I don’t believe in just sitting there and trying to dream it up all yourself. Nobody’s that smart.” – Charlie Munger
This is the opening quote from Meb Faber’s Invest with the House. In the book, Meb details the returns an investor would have experienced had they cloned the top 10 holdings of twenty, long-term oriented value investors from 2000 through 2014. On average, a cloning approach beat the S&P 500 by ~10% annually during this time period. Furthermore, one of my favorite super-investors, Mohnish Pabrai, also endorses a cloning approach in many of his lectures. He even developed a strategy, much like Meb, and calls it The Shameless Cloner portfolio. This information led me on a journey to discover the hidden power that 13F filings held for retail investors.
In short, the SEC requires that any fund manager who manages over $100M disclose their prior quarter holdings to the public every February 14th, May 15th, August 14th and November 14th. These disclosures are known as 13Fs and allow the public to see what stocks the best money managers in the world are investing in. For those of us who have dreamed of investing with the likes of Warren Buffett, Mohnish Pabrai, David Tepper, and David Einhorn, to name a few, 13Fs give us that opportunity. Thus, The Capital Clone was born.
Using a Roth IRA at Motif Investing, I plan to allocate $5,500 annually to a cloning strategy and track it here at Seed of Tomorrow. Motif Investing allows investors to build their own motif, or ‘mutual fund’ of sorts, comprising of up to 30 stocks or mutual funds. My motif will consist of 24 to 30 holdings, depending on number of cloned managers and associated holdings.
Cloning Strategy Pros & Cons
Cloning hedge fund managers can produce outsized returns for investors who stick with a set strategy over the long haul. However, this approach does come with it’s own unique pros and cons. Unlike other investing strategies, the success of cloning relies much more heavily on the evaluation of the manager rather than the underlying stocks. This is not an exhaustive list but here are some of the pros and cons of a cloning strategy:
- Access & Transparency
- Lower Fees
- 45-day Reporting Delay
- High-turnover Strategies
- Inconsistent Manager Skill
What makes 13F’s so great is that you get access and transparency into the minds of the world’s best investors. By following a cloning approach, you are not subject to hedge fund lock-up periods nor the high management and performance fees. Cloners can invest alongside the best money managers while maintaining high portfolio liquidity and paying less in fees.
However, several downsides exist to this strategy. Manager evaluation is paramount. The managers you select should all exhibit a common trait: long-term investing horizons. Since there is a 45-day reporting delay on 13Fs, you want to select managers who do not have high-turnover strategies. The portfolios of managers who trade too frequently will probably be very different from the portfolios reported in the 13F. Furthermore, you want to keep a pulse on the consistency of the manager. The tricky part of this strategy is knowing whether a manager’s under-performance is simply part of committing to a long-term strategy or due to undesired factors. Are they drifting from their long-term strategy? Have they experienced a personal tragedy? Are their skills diminishing? Or are they invested in deep value businesses whose value has not yet been recognized by the market?
Since manager evaluation is of the utmost importance with this strategy, the rules I set forth below are designed to enhance the pros and nullify the cons. My expectation for the portfolio is that I will receive the market-beating performance of each managers’ highest conviction ideas while minimizing the cons through manager diversification. I developed the following rules by blending those set forth from Meb Faber’s Invest with the House and Mohnish Pabrai’s The Shameless Cloner.
- Identify 6-10 fund managers with long-term market beating performance (Invest with the House and The Shameless Cloner are great resources for ideas).*
- Equity portion of fund is less than $50B in size.*
- Top 10 Holdings account for 50% or more of the portfolio.*
- Top 10 Holdings average time held is 6 quarters or more.*
- Invest in the #2 through #6 holdings of each manager (see table below for holdings). My clone invests in #2, #3, and #4 holdings.*
- If two or more managers hold the same stock in their #2 through #6 holdings, move to the next stock. All selections should be different.
- All stock selections have equal weighting.
- The portfolio is rebalanced quarterly by the end of the month in which the 13F was released.
- The old companies that are not in the new portfolio are sold and the “sell money” is distributed equally among all new entrants and remaining stocks.
- All positions, new and old, are rebalanced to equal weighting each quarter.
- If there are duplicate holdings in the new entrants, follow Stock Selection Rule #2.
- Dividends are accumulated and reinvested during the next rebalance.
- If there is an involuntary removal through acquisition/delisting/bankruptcy then the cash is accumulated and reinvested during the next rebalance.
- If there are any spin-offs, follow Rebalance Rule #2 during the next rebalance.
*Additional Notes about the Rules
- The number of managers you clone can fluctuate over time depending on a number of factors: style drift, retirement, diminishing skill, etc.
- Law of Large Numbers: The larger the fund size, the harder it is to outperform. As great as he is, my clone does not follow Warren Buffett because it is harder to outperform with an equity fund north of $100B.
- Concentrated, High Conviction Ideas: The more concentrated their portfolio, the more likely the fund manager has performed thorough due diligence before investing. Exceptions exist, as with Ariel Investments, LLC (see table below).
- In order to avoid high-turnover strategies, the average holding time of the Top 10 should be 6 or more quarters (18+ months). This also provides a buffer to the 45-day reporting delay.
- The #1 Holding is intentionally not cloned. Based on Meb Faber’s research in Invest with the House, it was found that Holding #1 was the worst performing cloned stock. Meb hypothesizes that the stock became the #1 holding through price appreciation, rewarding the manager for their past, not present, conviction. In essence, this holding was originally a #2 through #10 holding but price appreciated to #1.
Fund Managers Being Cloned
All of the managers I am cloning share a common trait: long-term investing horizons. While their strategies may differ slightly, they each look for companies that are trading below their intrinsic value to invest in for the long haul. I will not detail the strategy of each manager here. Meb Faber and Mohnish Pabrai do an amazing job of describing the history and strategy of these investors. For further information on Meb and Mohnish, please visit my resources page.
|Fund Name||Fund Manager||Fund Size||Top 10 Weighting||Turnover (Most Recent Qtr)||Top 10: Average Time Held (Qtrs)|
|Avenir Corp.||Charles Mackall, Jr.||$1.13B||64.6%||11.11%||24.8|
|Ariel Investments, LLC.||John Rogers, Jr.||$8.46B||24.6%||14.13%||11.5|
|Baupost Group||Seth Klarmann||$8.75B||72.1%||24.39%||7.7|
|Yacktman Asset Management LP||Donald Yacktman||$10.28B||79.5%||13.64%||23.6|
|Ruane, Cunniff & Goldfarb Inc. (Sequoia)||David Poppe||$10.81B||51.1%||31.43%||17.2|
|PAR Capital Management Inc.||Paul Reeder III||$8.90B||61.1%||23.53%||9.6|
|Markel Corp.||Thomas Gayner||$4.69B||42.4%||3.62%||23.8|
|Pabrai Investment Funds (Dalal Street)||Mohnish Pabrai||$0.405B||100%||16.67%||8.3|
|Greenlight Capital Inc.||David Einhorn||$6.20B||79.1%||48.48%||6.9|
|ValueAct Holdings, L.P.||Jeffrey Ubben||$11.19B||91.3%||6.67%||7.6|
The following holdings will be updated by the end of the month in which the 13Fs are released: February, May, August, and November.
|Fund||2016: Q4 13F||2017: Q1 13F||2017: Q2 13F||2017: Q3 13F|
|Avenir Corp.||AMT ~ DENN ~ KMX||MKL ~ DENN ~ MSFT||MKL ~ DENN ~ MSFT|
|Ariel Investments, LLC.||KMT ~ FAF ~ BRS||KMT ~ FAF ~ LH||FAF ~ BIDU ~ LH|
|Baupost Group||VSAT ~ SYF ~ AGN||FOX ~ VSAT ~ CLNS||SYF ~ VSAT ~ CLNS|
|Yacktman Asset Management LP||PG ~ PEP ~ ORCL||PG ~ PEP ~ CSCO||PG ~ PEP ~ ORCL|
|Ruane, Cunniff & Goldfarb Inc. (Sequoia)||TJX ~ XRAY ~ MA||TJX ~ KMX ~ XRAY||GOOG ~ TJX ~ KMX|
|PAR Capital Management Inc.||EXPE ~ DAL ~ CI||EXPE ~ DAL ~ CI||EXPE ~ DAL ~ MCK|
|Markel Corp.||WBA ~ DIS ~ BAM||WBA ~ BAM ~ DIS||BAM ~ DIS ~ WBA|
|Pabrai Investment Funds (Dalal Street)||GM.WS.B ~ GOOG ~ AER||GM.WS.B ~ GOOG ~ AER||GM.WS.B ~ AER ~ RACE|
|Greenlight Capital Inc.||MYL ~ TWX ~ CNX||MYL ~ AAPL ~ CNX||AAPL ~ MYL ~ CNX|
|ValueAct Holdings, L.P.||BHI ~ FOX ~ CBG||CBG ~ WLTW ~ ADS||ADS ~ FOX ~ CBG|
*Note: Anyone who invests in any strategy needs to do their own research/due diligence. They are themselves fully responsible for the outcome.