PSHZF - Pershing Square: Attractive Buying Opportunity For The Long Term

2024-01-16 04:38:07 ET

Summary

• Pershing Square has a solid track record of delivering returns that have averaged 15.7% per year, after fees since the fund's launch in 2004.
• With 26% insider ownership, management has a significant stake in the company. Its interests are aligned with shareholders, and this ownership stake has steadily increased over time.
• Management is buying back shares below NAV, increasing NAV per share, while also consolidating ownership for the remaining shareholders. Over the last six years, the company has repurchased 24.6%.
• PSHZF is likely to continue to outperform the market and will likely trade at net asset value or above at some point in time.

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I recommend Pershing Square (PSHZF) as a long-term investment due to many factors. Let me start by introducing the fund. Pershing Square is a Guernsey-based closed-end fund skilfully managed by William Ackman, a renowned value investor.

Pershing Square boasts a substantial market capitalization of £6.5 billion and is listed on the London Stock Exchange under the ticker PSH. Additionally, investors have the option to purchase shares of Pershing Square on the Amsterdam Stock Exchange under the ticker PSH or in the USA under the ticker PSHZF.

Typically, I steer clear of investing in funds, confident in my ability to outperform most fund managers, especially after fees. However, Pershing Square is an exception that has captured my attention. Considering the fund's strong history of performance, substantial insider ownership, and share buybacks, it's evident that the fund merits a valuation at or above its NAV.

To delve deeper, my interest in this particular fund is driven by several compelling reasons:

Outstanding Returns

Pershing Square has a solid track record of delivering returns that have averaged 15.7% per year, after fees, since the fund's launch in 2004. This is 6.7% higher than the S&P benchmark index, indicating that the investment manager has contributed significantly over fees. Additionally, the fund has returned over fifteen times the initial investment since 2004.

Sound Investment Philosophy

With my extensive knowledge in value investing, I believe that Pershing Square, guided by Bill Ackman's leadership, is well-positioned for sustained superior performance. Pershing Square stands among a notable group of similar funds that have demonstrated success, such as Berkshire Hathaway ( BRK.A , BRK.B ), Baupost Group, Gotham Asset Management, Greenlight Capital (GLRE), and Pabrai Investment Funds, among others.

What else do I like?

I appreciate Pershing Square's strategy of making significant, targeted investments and taking an active role in managing them. Ackman's proactive involvement in the companies he invests in is likely to continue adding value to the fund.

Additionally, I support the concept of a concentrated portfolio, which, contrary to traditional investment wisdom, can yield higher returns when managed by a fund manager adept at identifying undervalued companies. In such cases, assigning greater weight to these undervalued companies can lead to superior returns.

Furthermore, I believe that a portfolio of approximately ten stocks offers adequate diversification. Beyond this, the benefits of diversification tend to diminish.

Pershing Square's capacity to utilize various investment strategies, such as leveraging, taking long and short positions, and trading in derivatives, sets the stage for exceptional returns, albeit with accompanying risks. This broad mandate and operational flexibility could pose significant risks if not managed adeptly. However, under its current exemplary management, Pershing Square skilfully navigates these complexities, harnessing this flexibility to its advantage.

Why is the Market Mispricing Pershing Square?

The market's undervaluation of Pershing Square can be attributed to several nuanced factors:

Prevailing Misconception of Market Efficiency: There's a prevalent belief in financial theory that markets are inherently efficient, attributing any excess performance to mere chance. This perspective overlooks the reality of market inefficiencies and discredits the consistently exceptional track records of some investors, which would be implausible in a truly efficient market. I disagree with the market's consensus which leads many to conclude that the fund's future performance, post-fees, will underperform in comparison to an index, leading to its trading below its net asset value. I believe that Pershing Square will continue to outperform the market and I expect the discount to NAV to narrow as investors become more aware of this over time.

Perceived Investment Risks: Many investment platforms issue warnings before purchasing these shares, labeling them as high-risk and for sophisticated investors. This perception stems from the fund's fee structure, its concentrated portfolio, utilization of leverage (albeit within very reasonable bounds), capabilities for short selling, and engagement with derivatives. Ackman's prior experience in running a hedge fund, which he later transitioned into this current structure, further intensifies this wariness, as hedge funds are generally viewed as riskier investment vehicles.

Volatility in Performance: The fund has experienced significant fluctuations, including a notable loss exceeding 20% in a single year. This volatility challenges the investor's preference for stable and predictable returns. Many investors struggle to cope with such unpredictability, which in turn affects their investment decisions regarding the fund.

Estimation of Future Returns

The following is an estimated projection of Pershing Square's fund performance over an extended period, such as the next 20 years. While it's important to recognize that predicting future outcomes, especially over such a long timeframe, is inherently uncertain, this calculation aims to provide a reasonably accurate forecast. This projection is based on available data and trends, with the understanding that actual future performance may vary due to a multitude of unpredictable factors.

1. Ackman's performance, averaging annual returns of 15.7% after fees since the fund's inception in 2004, forms the foundation of my analysis. I have taken this average as a starting point and applied the adjustments detailed below.

For disclosure purposes, the fixed fees are 1.5% per year, and a performance fee of sixteen percent applies when the Net Asset Value ((NAV)) is above the previous performance fee payment (i.e., the high-water mark is zero percent)

2. Pershing Square's assets under management have expanded from $500 million in 2004 to over $11 billion. It's generally easier to achieve higher compounding rates with smaller capital bases. For instance, from January 1, 2004, to December 31, 2014, Pershing Square, L.P. compounded at an annual rate of 20.8%. However, I've conservatively adjusted the estimated return downwards by 2% per year, recognizing that larger capital bases often face challenges in maintaining high growth rates. This is partly because large-capitalization stocks, which Pershing Square often targets, are usually more efficiently priced and extensively covered by analysts.

3. The current overheated state of the US market suggests potentially lower future returns. Indicators like the Buffett Indicator, the Shiller P/E ratio, and the Inverted Yield Curve support this view. Given Pershing Square's focus on the US market, its performance is likely to be influenced by these market cycle stages. Nevertheless, the fund's flexible mandate, which includes options to go short and buy derivatives, provides a hedge against macroeconomic events. Ackman's proven track record in predicting global macro and geopolitical events is also a significant factor. However, due to the overvaluation in the US market and the likelihood of a future recession, I have further reduced the projected return by 3%.

4. Pershing Square is now closed to external investors, enabling Bill Ackman to concentrate solely on identifying optimal investment opportunities. This closure means less need for capital raising and less vulnerability to redemptions in challenging times, allowing for a more focused long-term strategy. I have adjusted the return projections upwards by 1.5% to reflect this advantage.

5. Ackman's commitment to avoid future short selling is likely to positively impact the fund's returns. While past short positions have led to losses and significant risks, primarily due to factors like a short squeeze and personal disputes, the post-exit decline in the value of these positions validates Ackman's initial analyses. Consequently, I have increased the return estimates by 1% to account for this strategic shift.

6. The fund's strategy of repurchasing shares below net asset value is enhancing the NAV per share and consolidating ownership among remaining shareholders. Over the past six years, the company has repurchased 24.6% of its shares. This action is beneficial to the fund's performance, and I have factored in an additional 1% increase in the return estimates to reflect this.

Additional Favorable Aspects

Financial Strength

Pershing Square's bonds have a weighted average cost of 3.1%, are unsecured, fixed-rate, long-term, and do not create margin calls. The company has access to over $1 billion in spare cash, and its total debt-to-total capital ratio is 19.5%. This type of leverage does not pose a substantial risk to the company's going concern and will likely enhance returns.

Insider Ownership

The substantial insider ownership in the company, amounting to 26%, signifies that management and affiliates hold a meaningful stake. This alignment of their interests with those of the shareholders is a key factor for me. Moreover, the fact that this ownership has been progressively increasing over time underscores its significance. For me, minimizing agency costs is crucial in most businesses, and I place a high value on having a fund manager who is also an invested shareholder.

Tax Benefits and Listing Location

Pershing Square is a closed-ended investment company domiciled in Guernsey, a tax haven that allows the company to keep 100% of its earnings.

The London listing eliminates the need to pay foreign exchange fees to access the US market.

Dividend and Reinvestment Program

The shares of this investment offer an annual dividend of 1%, which investors have the option to reinvest automatically through a dividend reinvestment program. I personally favour this reinvestment strategy, considering Pershing Square's impressive track record of compounding capital at rates surpassing 15%. This approach capitalizes on Ackman's financial acumen, potentially leading to significant growth over time. However, it's important to acknowledge that some investors might prefer receiving this dividend as a steady stream of income, valuing the immediate financial benefit over the potential for long-term compounded growth.

Auditor

Ernst and Young, a well-known and respected auditor, has audited Pershing Square since 2012, with low turnover showing a lack of disagreement between management and auditors.

Auxiliary Benefits

This is a buy-and-hold investment with a long-term horizon. All I have to do is wait. There is no churn as is common in cigar butt-type investing and no need to find reinvestment opportunities.

Risks

Volatility Of Fund Performance

Fund performance has been volatile as Bill concentrates the fund in about ten positions. In this investment, you must be able to withstand volatility and be a longer-term investor. Luckily, I can wait and leave this money for a long period.

Key Man

If Ackman dies, the fund's performance will probably be worse than the historical record. Luckily, he is only fifty-six years old, in good health, and has a long run ahead of him.

US Economic and Political

This is the biggest risk in my opinion.

Presently, the United States stands as a nation marked by division and fragmentation, prompting several scholars to perceive it as an advanced society approaching a potential decline in its historical dominance.

To enumerate a few of its pressing internal challenges:

1. Erosion of the middle class

2. Wide wealth disparities

3. Escalating debt levels and the imminent conclusion of a long-term debt cycle

4. Partisan and biased media landscape

5. Erosion of shared values

6. Heightened polarization

7. Ethnic and religious conflicts

8. Contested election processes

In conclusion, the United States finds itself in a transformed state, no longer reflecting the stability and prosperity it once embodied.

In a recent LinkedIn Article, prominent fund manager Raymond Dalio has expressed a noteworthy concern, estimating a 30 percent likelihood of the United States experiencing some form of civil unrest in the coming decade. This assessment holds considerable merit, in my perspective.

Conclusion

The estimated compounded return is 14.41% per year.

An investment company with a solid track record should trade above NAV, making this discount an attractive buying opportunity. I expect this gap to narrow, eventually causing the share to trade at NAV or higher. Closing the gap will add to compounding performance and boost returns by an additional 47%.

If the fund continues to earn 14.41% per year and then trades at NAV, a £20,000 investment will equal £434,311 in twenty years - just in time for my early retirement.

P.S. It's important to note that attempting to replicate Pershing Square's performance by merely mirroring the fund's publicly disclosed positions is not feasible. This is because a significant portion of the fund's overall success can be attributed to Bill Ackman's strategic macroeconomic bets and hedges. These manoeuvres, which are not always visible in the fund's disclosed positions, have played a pivotal role in driving the fund's returns. Additionally, the profits generated from these additional strategies have more than compensated for the fees incurred.

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