Pershing Square Holdings (PSH) is a closed-end fund with net assets of £7.2bn, and the flagship fund of Pershing Square Capital Management led by Bill Ackman. Pershing Square is variously known as a ‘hedge fund’ or ‘activist’ manager, but a fundamental value investor is probably a fairer description. At times, hedging may be employed, seemingly to protect from large sell-offs rather than create a low volatility return stream.
The portfolio is highly concentrated, with eight to 12 core holdings at any one time. Disclosure on holdings is poor, but we believe that PSH currently has only ten long positions, with some additional hedging. Pershing Square’s strategy is to acquire smaller pieces of ‘superb’ businesses over which they can have substantial influence, rather than controlling interests in lower quality businesses.
At times, when the manager perceives that risks are extended, Pershing Square has employed hedges. In 2008, Pershing Square generated significant gains from holding CDS in monoline insurers. More recently, in February 2020, Pershing Square entered into CDS on corporate bonds at narrow spreads over treasuries. Spreads widened very soon after the trade was initiated, generating very significant gains, the proceeds of which were reinvested (with exquisite timing) in mid-March.
As we discuss in Performance, the combined annual return of the strategy from 01/01/2004 to 23/03/2021 is 17.1% per annum, against which the S&P 500 delivered an annualised return of 9.8% per annum. In recent times, performance has been flattered by two very strong years it achieved in 2019 and 2020. The period from 2015 to 2018 inclusive was poor and, as we discuss in Discount, is a key reason why the shares trade on a very wide discount.
2020 was the best year of performance since inception. Of the 70% gains in the year, those from the CDS hedge and subsequent reinvestment (for more information, please see Portfolio) delivered NAV returns of c. 55%. Is it perhaps the ’one-off’ nature of this alpha delivered during 2020, that has not led the market to value the manager’s performance more highly, and reward it with a narrower discount?
The period 2015 to 2018 represented a difficult period for the manager. Demand for PSH’s shares lagged during this period, and resulted in a very wide discount which at times broached the 30% mark. The current discount is around 25%. We believe that poor disclosure (on the underlying portfolio, and with only weekly NAV estimates) and high fees are key areas that makes it hard to see PSH achieve a dramatic re-rating in the immediate term. That said, when taken on its fundamentals, PSH offers a highly idiosyncratic strategy that has compounded at an attractive rate and would likely complement a diversified US equity portfolio, or portfolio of funds.
For those that have patience and a tolerance for the risk presented by a highly concentrated portfolio, there are relatively few candidates in the investment trust universe that are available at a discount anywhere near the 25% level that PSH currently trades at. We note that further buybacks will be accretive to the NAV at this level, and accounted for 2.4% NAV returns during 2020.
|Wide discount to NAV which, despite lack of obvious catalyst to close, means future buybacks will continue to be accretive
||Structural gearing brings higher financial risk / volatility of NAV
|Highly regarded manager, who has delivered idiosyncratic return profile historically
||Concentrated portfolio means returns can be meaningfully impacted by one company
|Large insider ownership means, whilst there are high fees, the team are motivated to generate returns
||Poor disclosure and high fees
Pershing Square Holdings (PSH) is a closed-end fund with net assets of £7.2bn. It is the flagship fund of Pershing Square Capital Management (Pershing Square), a US manager led by Bill Ackman. Pershing Square is variously known as a ‘hedge fund’ or ‘activist’ manager. In the past, Pershing Square had large single stock shorts, but following the well-publicised events with Herbalife (a significant short position which did not pay off for Pershing Square), single stock shorting has become less of a feature. As such it is probably fairer to say that Pershing Square is a fundamental value investor that can (although doesn’t always) use a range of activist strategies to generate returns. At times, hedging may or may not be employed. In general, it would appear that hedging is employed to protect from large sell-offs, rather than create a low volatility return stream. In seeking to achieve this, the fund can employ complex derivative hedging strategies to protect capital, or may look to short individual stocks.
Whilst the strategy has evolved over time, the portfolio has retained one characteristic: that of being highly concentrated. The portfolio will typically be invested in eight to 12 core holdings at any one time. Up to date disclosure on holdings is poor, but we believe that PSH currently has only ten long positions, with some additional hedging. At 31/12/2020, the largest individual position (Lowe’s Companies) represented 18.8% of NAV. We illustrate what we believe are the current holdings in the table below, but note that up to date position sizes are not available. As we discuss in Gearing, PSH has long-term structural gearing in place. However as at 31/12/2020, cash on the balance sheet broadly covered much of this gearing, such that the overall invested position (or equity exposure as a % of NAV) was c. 105%.
|Chipotle Mexican Grill|
|Restaurant Brands International|
|Howard Hughes Corporation|
|Federal National Mortgage Association (Fanny Mae)|
|Federal Home Loan Mortgage Corporation (Freddie Mac)|
|Pershing Square Tontine Holdings, Ltd.|
|Interest rate swaptions|
Source: Kepler Partners LLP
In terms of looking for investments, Pershing Square says that it seeks to invest in excellent businesses with opportunities for improvement. These businesses tend to be large cap companies that generate relatively predictable and growing free-cash-flows, with strong barriers to entry and a compelling value proposition at the time of investment. The manager believes that shares of even the best businesses can trade at almost any price for brief periods. And it is this volatility – often driven by a disappointing short-term event, missed expectations, macro factors, political events, shareholder frustration with management and/or governance – that has enabled them to acquire large minority stakes in what they see as great businesses at bargain prices. More formally put, Pershing Square aims to identify significant valuation discrepancies between share prices and intrinsic value, often with a catalyst for value recognition, which will enable it to crystallise its investment. PSH employs an active investment strategy, but with the closed-end structure, can afford to commit to investments for the long term.
The manager believes PSH should best be thought of as a tax-efficient investment holding company that owns minority interests in public companies which are of a quality and scale where legal control is often difficult if not impossible to achieve. Pershing Square’s strategy is to acquire smaller pieces of ‘superb’ businesses over which it can have substantial influence, rather than controlling interests in lower quality businesses. As a manager Pershing Square has generally owned less than 20% of investee companies, and usually less than 10%. Even so, Pershing Square is typically one of the largest shareholders of its investee companies, and sees itself as an influential and supportive owner over time. However, as has been the case with several investments (such as Starbucks), if the share price returns exceed its targets and the team find more attractive opportunities elsewhere, Pershing Square will exit positions. Having invested in Starbucks in the summer of 2018, the shares were sold in entirety in January 2020, booking a 73% return over 19 months (Source: Reuters). In the throes of the pandemic, the share price of Starbucks fell, and PSH re-acquired a stake in March 2020. As detailed in the latest report and accounts, in Q1 2021 with the share price around twice the price it paid a year ago, Pershing Square once again sold the holding.
Pershing Square aims to generate long-term returns from value investing, but at times (when the manager perceives that risks are extended) also seeks to generate extra value (or protect capital) by hedging. In the past Pershing Square has generated significant gains during crisis points through credit default swaps (or CDS). In 2008, Pershing Square generated significant gains from holding CDS in monoline insurers MBIA and Ambac. More recently, in February 2020, Pershing Square entered into CDS on corporate bonds at narrow spreads over treasuries. When the impact of the pandemic became clear, spreads widened dramatically, generating very significant gains and largely offsetting the share price falls elsewhere in the portfolio. Over Q1 2020, PSH’s NAV was +3.3%, with a maximum loss in March 2020 of 11.2% against 30.4% for the S&P 500. The timing of this trade was almost perfect – by luck or judgement. The CDS owned by PSH required a monthly payment of c. $20m but, given spreads widened very soon after the trade was initiated, Pershing Square only had to make one payment before crystallising the $2.0bn position (click here for more information which examines the trade in depth). Pershing Square re-invested these proceeds in mid-March – largely by adding to existing portfolio holdings – at what turned out to be very advantageous prices. More latterly, towards the end of 2020, Pershing Square added to its protective strategies again by buying interest rate swaptions, designed to profit from an increase in interest rates. Over the first quarter of 2021, this position was reportedly the largest contributor to PSH’s returns over the first three months of the year. According to Pershing Square, “at a cost of $157 million [interest rate swaptions] represented 1.4% of assets” at the start of the year, but by the end of March 2021 had “more than tripled in value, and now represents 4.2% of the portfolio with a market value of $493 million”.
At times, these hedges have clearly added very significant alpha. But we note that PSH’s strategy does not entail hedges being run continuously. We believe that market timing is notoriously difficult to consistently add value through. However, Pershing Square seems to have hit more than its fair share of home runs in this regard. Using a combination of option like strategies (like CDS or swaptions) and being able to recognise when markets are over-optimistic or priced for perfection, perhaps the odds are more tilted in the manager’s favour. But it remains to be seen whether Pershing Square will continue to be able to add value in this way. During 2020, these hedging activities contributed most of the year’s gains, as we discuss in Performance. The manager believes that a buy and hold strategy with the same portfolio as PSH would have generated c. 15% during 2020. As it was, the CDS and reinvestment of the proceeds into equities as well as other hedging contributors, meant that the total return was c. 70%, a hedging and subsequent reinvestment gain of c. 55% on the NAV at the start of 2020. Of course, there can be no certainty that PSH will have hedging in place in future crises, but the manager believes that its investment process which favours high quality businesses, with barriers to entry will prove more resilient than the broader market when markets sell off.
One final feature of the portfolio that is worth highlighting, which also has option-like characteristics, is the holding in a SPAC (Special Purpose Acquisition Company) which is sponsored by Pershing Square. Pershing Square has prior form in SPACs – in 2012 sponsoring Justice Holdings, which took a 30% stake in Burger King public, having bought it from a private equity manager. With the help of Berkshire Hathaway, Burger King purchased Tim Hortons, to become Restaurant Brands (which is still in the portfolio today). We understand that PSH has made several times its originally invested capital.
The latest SPAC sponsored by Pershing Square is Pershing Square Tontine Holdings Ltd listed on the New York Stock Exchange in July 2020 and aims to combine with a private business, which will result in PSH owning a minority shareholding in a newly listed public company. This SPAC raised $4bn in its IPO, with Pershing Square funds (including PSH) agreeing to contribute an additional $1bn, with the option to increase the investment up to $3bn. In addition, Pershing Square funds (including PSH) purchased a ‘Sponsor Warrant’ which gives additional upside depending on how the share price of the entity performs. This contrasts with typical SPAC transactions, where usually the sponsor warrant is owned by the investment manager. However, in this case, the sponsor warrant is 100% owned by Pershing Square funds, ensuring that the manager’s incentives are fully aligned with the performance of the funds, and that there is no conflict of interest between the manager and PSH. If the team are successful in completing a transaction, the manager expects that the SPAC and associated sponsor warrants will be an important contributor to performance. The reason why this investment resembles an option is that if, after the necessary time elapses and a transaction isn’t achieved, then PSH will have lost no capital. Yet if a successful transaction is achieved, the investment stands the prospect of generating handsome returns for the fund.
PSH has structural gearing in place through bonds it has issued (both publicly traded and private), with a range of maturities from 2022 to 2039. It has total debt of $2.1bn, which at the NAV as at 16/02/2021 represented potential gearing of 17.7%. As we discuss in Portfolio, as at 31/12/2020 cash brought effective gearing down to c. 5% although – as we also discuss in the section – disclosure on the portfolio is poor and so gearing could be significantly different. $1bn of the bonds (i.e. nearly half of PSH’s gearing) are redeemable in July 2022, and pay a chunky coupon of 5.5%. Since June 2015 when they were issued, the NAV of PSH has more than doubled, such that a refinancing of these bonds at a significantly lower coupon seems likely achievable assuming credit or interest rate conditions do not deteriorate significantly. We note that during 2020 PSH issued two longer dated bonds (2030 and 2032 maturity) with coupons of 3.25% and 3%. The weighted average cost of PSH’s bonds is 4.6%. PSH is restricted such that borrowing as a percentage of total assets shall not exceed 50% at the time of incurrence of any borrowing or its drawdown. We note that on a net asset basis, this is equivalent to 100% of NAV.
In another way, PSH can also be seen to employ gearing through its use of derivatives, such as equity and credit derivatives and put options, to achieve a synthetic short position in a company without exposing it to some of the typical risks of short selling, which include the possibility of unlimited losses and the risks associated with maintaining a stock borrow. PSH generally does not use total return swaps to obtain leverage, but rather to manage regulatory, tax, legal or other issues. As such, investors should be aware that, depending on the use of such derivatives, the portfolio will not necessarily display a beta similar to other funds and in some circumstances could reflect the impact of highly geared instruments.
PSH commenced trading on Euronext in Amsterdam in October 2014. In May 2017, PSH was also listed on the main market of the London Stock Exchange. Prior to this, Pershing Square ran private funds since the formation of the management company in 2004 which constitute the track record prior to the listing. The combined annual return of the strategy from 01/01/2004 to 23/03/2021 is 17.1% per annum, against which the S&P 500 delivered an annualised return of 9.8% per annum. That said, as the graph below shows, these long-term performance numbers have been flattered by two very strong years in performance terms achieved in 2019 and 2020 which we examine in more detail below.
Manager track record
Past performance is not a reliable indicator of future results
The period from 2015 to 2018 inclusive were poor years for Pershing Square and, as we discuss in Discount, are in our view the key reason why the shares trade on a wide discount even now. However, 2019 and 2020 were very strong in absolute and relative terms, which has allowed PSH to recover some (but by no means all) of the lost ground since IPO which we show in the graph below.
TOTAL RETURNS SINCE IPO
Past performance is not a reliable indicator of future results
2020 was the best year of performance since the inception of the strategy in 2004. PSH’s performance during the year was primarily driven by its purchase of index credit default swaps in February 2020, and the subsequent unwinding of those hedges in March, but also reinvesting the proceeds from the hedges as the markets recovered. Of the 70% gains made during the year (net of fees), the gains made from the CDS hedge (for more information, please see Portfolio) and subsequent reinvestment delivered returns of c. 55% on the NAV at the start of 2020. Is it perhaps the ’one-off’ nature of the alpha delivered during 2020, that has not led the market to value the manager’s performance more highly, and reward it with a narrower discount?
Past performance is not a reliable indicator of future results
According to Pershing Square, since the inception of the strategy it believes that it has significantly outperformed the S&P 500 principally due to hedging-related gains and investments in high-quality, durable, growth companies. Certainly, the strategy weathered 2020 exceptionally well, but we also note that during the Global Financial Crisis from December 2007 to June 2009, Pershing Square’s private fund outperformed the S&P 500 by 32% thanks to some astute purchases of CDS on monoline insurers. Pershing Square published information that it nearly matched the S&P 500’s return in up months (2.9% vs 3.0%), but captured much less of the downside in down months, delivering an average return of -1.8% against the S&P 500 return of -3.8%. In our view, whilst this may be the case, the strategy has proved to be consistently more volatile than the S&P 500 on a 12-month rolling basis, as is shown in the graph below. As we note in the portfolio section, PSH’s strategy is to deliver strong total returns, rather than deliver a lower volatility return stream.
12 Month rolling volatility vs S&P 500
Past performance is not a reliable indicator of future results
In order to try to address the discount, since February 2019 PSH has paid a quarterly dividend of $0.10 per share. At the current price, this represents a dividend yield of 1.1%. The manager does not invest for yield, but total returns. As such, whilst the portfolio’s underlying companies may pay dividends, this does not play a part in the board’s decision to pay dividends. As such, the dividend represents a return of capital at NAV.
PSH’s dividend yield compares to c. 1.45% for the S&P 500, and 1.3% for the weighted average of the AIC’s North America investment trust peer group. Dividends will be paid in USD unless a shareholder elects to be paid in GBP. Shareholders may also elect to reinvest cash dividends into PSH shares through a dividend reinvestment programme.
Pershing Square Capital Management (Pershing Square) was founded by Bill Ackman on 1 January 2004. Pershing Square now constitutes 39 employees, of which Bill Ackman leads an investment team of six. PSH represents the main bulk of assets under management, and the other private funds are no longer marketed to new investors. As at 31/12/2020, strategy assets under management (i.e. excluding Pershing Square Tontine, a SPAC) were $13.45bn, of which PSH was $11.9bn. PSCM affiliates own approximately 25% of PSH on a fully diluted basis (as at 31/12/2020).
PSH has an independent board of six individuals and is domiciled in Guernsey.
PSH has a dual listing on Euronext (denominated in USD) and the London Stock Exchange (denominated in GBP). As the graph below demonstrates, PSH’s GBP shares have traded at a persistently wide discount to NAV. Initially, after IPO, the shares traded on a premium. However, the period 2015 to 2018 represented a difficult period for the manager, during which broader equity markets generally, and the S&P 500 specifically, outperformed. Demand for PSH’s shares lagged during this period, and resulted in a very wide discount which at times broached the 30% mark.
The board says that it monitors the discount closely and seeks opportunities to narrow it. In this regard, the board has powers to buy shares back, and this power has been used. Since 2 May 2017, when PSH initiated its first share repurchase programme, the company has repurchased 50.8 million shares at a total cost of $837m at a discount of 26.5%. The last buyback to occur was on 03/09/2020, at an estimated discount to NAV of 29%.
Lasting solutions to the discount, or a specific catalyst that would result in a re-rating are hard to identify. The articles of association requires that a winding up or termination of the management agreement requires a 75% vote in favour of such a resolution. Given that affiliates of the management company own c. 25% (on a fully diluted basis), then it seems likely they have a blocking vote. The board has undertaken a number of steps to address the discount, including obtaining a premium listing on the London Stock Exchange, repurchasing 21% of shares outstanding (since IPO), and initiating a quarterly dividend.
In December 2020, PSH gained entry to the FTSE 100, which should help attract demand from investors at the margin. We believe that poor disclosure (on the underlying portfolio, and with only weekly NAV estimates) and high fees are key areas that make it hard to see PSH achieve a dramatic re-rating in the immediate term. Given the large ownership of management in PSH, it seems unlikely that the fee arrangements will change. And in terms of disclosure, the company is caught between a rock and a hard place. With such a concentrated portfolio, increasing the levels of disclosure will allow ‘replicators’ to follow the manager’s investment strategy (albeit they are unlikely to be able to replicate the hedging aspects, which have delivered such huge value during 2020, and to the present day) and ‘free-ride’ on the investment work that the Pershing Square team put in. On the other hand, without better disclosure, investors are likely to remain wary of a strategy that can react in very different ways to other funds.
That said, when taken on its fundamentals, PSH offers a highly idiosyncratic strategy that has compounded at an attractive rate and would likely complement a diversified US equity portfolio, or portfolio of funds. In February 2021, the manager observed the irrationality presented by discount rating of PSH when compared to Pershing Square’s SPAC (Pershing Square Tontine) which at the time traded at a 33% premium to its IPO price and consisted of nothing by cash. Since then, we observe the SPAC’s premium has eroded somewhat but still remains, and PSH’s discount remains wide. We observe that, for those that have patience and a tolerance for the risk presented by a highly concentrated portfolio, there are relatively few candidates in the investment trust universe that are available at a discount anywhere near the 25.7% level that PSH currently trades at. Further buybacks will be accretive to shareholders, which accounted for 2.4% NAV returns during 2020.
PSH pays the manager Pershing Square Capital Management (Pershing Square) a fee of 1.5% of net assets. In addition, the manager is paid a performance fee that crystallises annually, equal to 16% of the NAV appreciation above a high water mark. For the year ended 31/12/2020, the manager earned performance fees of c. $696m.
In addition to the management and performance fees, PSH also pays other structure related costs, including fees for board members and transaction costs, as is usual. However, it is worth noting that given the manager can employ activist strategies, these costs can at times be very significant, and can include litigation. All of these costs are borne by the company, pro-rata with the other strategy assets run by Pershing Square.
The KID document provides more colour, and includes 2.58% of ongoing costs, performance fees of 2.06% and transaction costs of 0.53%. In total, the KID ‘reduction in yield’ figure is 6.02%.
Bill Ackman states that he believes that capitalism is likely the most powerful potential force for good in addressing society’s long-term problems. He observes that a successful business operating ethically and sustainably can create many thousands of high-paying jobs, deliver high long-term returns for pensioners, long-term savers and other investors, and provide goods and services that materially increase its customers’ quality of life, broadly defined. In summary, good ESG practices are fundamentally aligned with running a successful business. He believes that with well-aligned incentive structures, supportive corporate values, and strong leadership, a successful business can generate both strong returns for its shareholders, and positively impact the society and environment in which it operates.
The rise of ESG has prompted changes to the investment environment, with a growing number of investors becoming increasingly concerned about the risks of companies which do not take ESG issues seriously. These investors avoid investing in companies which do not meet high ESG standards, reducing the valuations and investment returns of these businesses, negatively impacting their cost of capital. As capital is reallocated away from companies that rate poorly on ESG issues, boards’ and managements’ likely response will be to pivot their company’s business models to ones that are better for the environment and society. As a long-term, concentrated and engaged owner of publicly traded companies, Pershing Square believes it can help accelerate this process in a manner that is closely aligned with its strategy, which seeks to generate high long-term rates of returns for shareholders.
The most important criterion in Pershing Square’s investment selection process is an assessment of the long-term quality of a business, which is informed by, among other considerations, assessment of the long-term impact of the company on all of its stakeholders and society at large. As a result, assessing the sustainability risks of a potential investment is a critical component of the investment selection process.
Pershing Square believes that its focus on business quality has largely enabled it to avoid investments in businesses which make products or deliver services which Pershing Square does not believe to be desirable, which treat its employees poorly, and/or which have long-term financial and legal risks that are a consequence of their negative externalities.
In many instances, the manager has chosen to invest in companies which already have excellent ESG practices, including good governance, robust environmental stewardship programmes, and diversity and inclusion initiatives. The majority of the companies in the portfolio exhibit those characteristics at the time of the initial investment, and all, to varying degrees, do so today.
Pershing Square provides some examples from the portfolio:
- For the third year in a row, Agilent ranked in the top three of Barron’s Most Sustainable Companies in America as it continues to invest in infrastructure improvements to further reduce its environmental impact.
- Starbucks has made significant investments in eco-friendly operations, regenerative agricultural practices, and an environmentally friendly menu, and has committed to cut its carbon, water, and waste footprints by half by 2030.
- Lowe’s is enhancing the sustainability of its products and promoting consumers’ ability to reduce their own environmental footprints through the sale of eco-conscious products. During the pandemic, Lowe’s invested more than $1bn in employee support, community donations, and enhanced store safety.
- The Howard Hughes Corporation (HHC) has set ten-year goals for energy, water, waste, and carbon emissions, and established an ESG Committee that reports directly to the CEO to guide its sustainability programme. HHC has regularly received awards for owning and managing communities and small cities that are considered among the best places to live in the United States.
In some instances, Pershing Square has used its influence and engagement with boards and management to improve ESG practices that pose sustainability risks to a business in order to catalyze long-term value creation. For example, Chipotle is a business for which sustainability has been a core value since its founding. For years, the company has earned accolades for sustainably sourcing its food, and for reducing its environmental impact over time. Consumers understand that the company’s commitment is genuine and reward it with their business. When PSH first invested in the company, the manager recognised that the opportunity to work with the company to improve its governance could create significant shareholder and stakeholder value, while allowing the company to continue to grow rapidly and stay true to its core values.
Following the investment, the board and management were refreshed, and have since done a remarkable job of turning around and accelerating the growth and profitability of the company. As evidence of the company’s continued commitment to good ESG practices, in March 2021, Chipotle announced that 10% of its officers’ annual incentive bonus will be tied to hitting ESG objectives.