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Pershing Square: buying opportunity or value trap?

Pershing Square: buying opportunity or value trap?

UK investors can now gain better access to US activist investor and hedge fund manager Bill Ackman after his Pershing Square Holdings (PSH) added a premium London Stock Exchange listing alongside an existing berth on Euronext in Amsterdam.

In the decade before Ackman launched PSH in 2014 he and his team had generated average annual return of 20.8% for investors in the US. Since then, however, performance has faltered and the £2.9 billion Guernsey-based investment company has achieved a 22.8% gross return, falling to just 7.1% when fees are deducted. By contrast, over the same period the US index, the S&P 500, has risen by 84%.

The decision to have a dual listing in London was driven by a desire to broaden PSH’s shareholder base and to improve its rating: before its move to London the shares traded at a hefty 16% discount below net asset value (NAV).

The company’s spectacular fall from grace has largely been caused by acquisitive Canadian pharmaceutical group Valeant (VRX.TO) - the fund’s largest position - which plunged after US regulators investigated accounting irregularities and allegations of 'price gouging'.

Ackman and his team sold out of Valeant in March at what is understood to be a loss of over 90%.

Understandably, he would like to draw a line under the whole debacle. However, the performance drag caused by Valeant is difficult to ignore, particularly as the pharma stock previously accounted for just over 19% of PSH’s NAV. Valeant’s share price fell 87% in 2016, causing PSH’s portfolio to tumble 13.5% and its shares to slide 28.2% over the same period.

Recovery play

In spite of this, a number of commentators suggest PSH could soon bounce back.

They point to the age-old argument that the best time to buy into the strategy of a star fund manager is often after a period of poor performance. This provides the manager with an opportunity to review their process and portfolio, as well as stopping any complacency feeding into their process. Finally, it can be down to timing if market conditions change and become favourable for their approach

Prospective investors in PSH will no doubt be asking themselves how Ackman and his team got things so wrong on Valeant?

And with the discount slightly lower at 15%, is the focused fund a buying opportunity or a risk too far?

One positive factor is the London listing which could provide some buying support for the shares. PSH will become eligible for inclusion in the FTSE 250 ‘mid cap’ index at its quarterly review in June, which would lead to significant buying activity from tracker funds.

James Carthew, investment company analyst at Marten & Co, said PSH had an odd structure with most of its voting rights resting with a special purpose vehicle called VoteCo, which the manager controls. ‘Both VoteCo and the actual investors need to approve things like changes to the investment policy, firing the manager and winding up PSH,’ he said.

The company has marked its move to London with a modest buyback programme in which it can buy up to 5% of its shares. Mopping up some of the excess supply could help narrow the stock’s discount this year.

James Burns, who manages multi-manager funds at Smith & Williamson, expects to see a recovery in PSH’s performance. With this in mind, he bought into PSH at listing for the Smith & Williamson MM Endurance Balanced fund.

‘With a fresh pair eyes it could be a good time to buy a manager like him [Ackman] after a period of poor performance. Any contrarians might view this as a great time to buy in,’ he explained.

He adds that investors who are more cautious will want to see some stability in performance before taking a position.

‘They need to have a good couple of years where they actually make some money, which will give people more faith in their process,’ he added.

Investment approach

Some investors classify PSH as a hedge fund due to the fact that the management team frequently use ‘in-the-money calls’ or options to buy an asset below its market price on or before a specific date.

However, Burns’ multi-manager team at Smith & Williamson prefer to view PSH as a high conviction US equity fund given its portfolio consists of 11 North American stocks (with 10 ‘long’ and one ‘short’ position).

Ackman has certainly made a name for himself as an activist investor. He targets companies that trade at what he thinks are good valuations, where there is turnaround potential. He then takes a private equity-style approach, taking positions on company boards and will even replace management if he deems it necessary.

Restaurant Brands (QSR.TO), which owns Burger King and other fast food chains, is currently the largest position in the portfolio. It accounted for 20.4% of assets at the end of March and was the biggest positive contributor to performance during the first quarter.

Mondelez (MDLZ.O), a US multi-national food and drink company, is the second largest position at 14.5% of the portfolio. Ackman is understood to echo the view of Finsbury Growth & Income (FGT) manager Nick Train that Mondelez could be ripe for a bid and currently looks undervalued, given its exposure to growth in emerging markets.

Ackman and the team are currently shorting Herbalife (HLF.N), betting that the developer and marker of nutrition supplements and weight management products is nothing more than a ‘pyramid scheme’. However, the call hasn't come good yet and was another performance detractor during the first quarter.

Last June, Herbalife agreed to pay $200 million to compensate customers after settling Federal Trade Commission charges that it had deceived consumers into believing they could earn substantial money through its compensation structure. This rewards distributors for recruiting others to join and purchase products in order to advance in the marketing program.

PSH expects the FTC settlement will weigh on Herbalife’s financial performance in the coming quarters.

‘Despite weak financial performance in the first quarter, Herbalife’s share price has appreciated by more than 50% year-to-date. We believe this is due in part to Herbalife’s misleading portrayal of its first quarter operating performance and the company’s share repurchase program,’ Ackman told shareholders in PSH’s first quarter update.

Performance bounce

Panmure Gordon investment company analyst Charles Murphy agrees with Burns that PSH has the potential to generate strong performance over the long-term.

‘Given that more vanilla US funds trade on single-digit discounts, the prospects that a premium London listing will deliver a tighter discount feels reasonable,’ said Murphy.

Mick Gilligan, head of fund research at wealth manager Killik & Co, says it is likely that PSH's discount narrows from here, given that it has undertaken a share buyback programme and is likely to join the FTSE 250 in June.

With this in mind, he says investors who like Ackman’s approach and are looking to benefit from the discount narrowing should consider investing sooner rather than later.

‘Over the near-term, it is more likely the discount narrows than it widens. If you want to buy it, you should probably buy it now for its short-term recovery value,’ Gilligan said.

Nevertheless, Gilligan considers investing in PSH now represents too much of a risk. Instead, he prefers to hold managers like Fundsmith's Terry Smith, who also has a bias towards cash-generative businesses.

‘Before Valeant, Pershing Square was very much in demand because it had close to an unblemished record. Now, I think private investors will be a little more circumspect and will probably wait for a period of stability in terms of performance before buying it,’ he explained.

Mona Shah, head of collectives research at wealth manager Rathbones, is not convinced that investors will flock to PSH any time soon.
‘Increased demand is debatable, given the poor sentiment overhang from the disastrous investment in Valeant. This means that performance since inception looks poor, even though the long-term track record of the US vehicle looks good,’ she said.

She also warns that the strategy is quite complex, so investors need to be clear about what they are buying.

Fees in focus

PSH has a 1.5% management fee, with a 16% performance fee above a high water mark – which is the highest value the fund has ever reached. This stands at an NAV of $26.37 per share, far above its NAV per share of $18.44 on 11 May.

Burns says the hedge fund-style fee structure must be a consideration for anyone thinking about investing in PSH, although on the plus side he welcomes the lack of performance fee right now.

‘They are miles beneath their high water mark, so you don't have a performance fee to worry about for some time,' he added.

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