Bill Ackman, billionaire founder of hedge fund Pershing Square Management, had a horrible 2015.
His fund delivered a -19.3% gross return.
Naturally, he had to explain why his fund performed so badly in a year-end letter to investors. One reason he gave was about other people who copy his trades.
You’d think that one of the benefits of being one of the most famous financiers in the world, and having $13 billion under management is that — when it comes to taking an idea into the market — people will follow your size, with size.
But there’s a downside to that, Ackman writes in his letter — one he hadn’t thought about before.
The problem is that the traders that are following Pershing into positions may not have the conviction or ability to hold as long as the fund does. So they sell when things get tough, though Ackman doesn’t seem to blame them for it. They have to stave off redemptions.
From the letter:
Perhaps the largest correlation in our portfolio is one that we have not previously considered; that is, the fact that we own large stakes in each of these companies. We have had the benefit of a “following” of investors who track and own many of our holdings. This has given us significantly greater clout than is reflected by our percentage ownership of these companies, and we believe that it is partially what has caused the “pop” in market price when we announce a new active investment. As a result, these active managers’ performance is often closely tied with ours. When Valeant’s stock price collapsed, our performance, and that of Pershing Square followers, were dramatically affected. Nearly all of these investment managers are subject to daily, monthly, and quarterly redemptions, and therefore, many were likely forced to liquidate substantial portions of their holdings which overlap with our own.
Ackman chose Valeant, a Canadian pharmaceutical company which was his biggest loser in 2015, to illustrate his point. The stock fell 66% from January 22 to the end of the year.
Valeant’s share price started falling in August, and the drop accelerated in October after accusations of malfeasance from a short-seller. Ackman touches on the ravages of this short seller attack in the letter [emphasis ours]:
We select investments based on business quality, discount to intrinsic value, and catalysts to unlock value, but not principally based on who else owns or will own the stock. The vulnerability of a company to an overall market decline, a short seller attack, or negative headlines is highly correlated with the nature of the investors who are the principal holders.
This relates to a separate point in his letter. Ackman notes that the majority of his holdings are not part of the S&P 500, and therefore do not have a large base of index fund shareholders. Companies like Mondelez and Zoetis are principally owned by index funds, according to Ackman, and appear to suffer from “much less volatility” as a result.
Here is Ackman again (emphasis ours):
The companies in our portfolio that have suffered the largest peak-to-trough declines are Valeant, Platform, Nomad, and Fannie and Freddie. The inherent relative risk of their underlying businesses and their more leveraged capital structures partially explain their greater declines in market value as markets moved to a “risk off” mentality. But their massive declines in value, in our view substantially more than can be accounted for due to fundamental issues in their respective businesses, cannot, we believe, be attributed to these factors. Importantly, none of these companies is in any of the important market indexes. Their shareholder bases are, therefore, largely comprised of hedge funds and other active managers, which we believe has contributed to their underperformance.
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