On Thursday, some not-entirely-surprising news surfaced. Hedge fund manager, once a star among the gain-seeking, risk-averse crowd, is on the defensive in a big way. His fund, Pershing Square, is seeing more and more cash-outs, as investors disappointed in his results simply want to take what’s left of their money and do something else with it.
The specifics: Once a fund valued at a little more than $20 billion at its 2015 peak, Pershing Square’s total assets under management has shrunk to a value of only $8.2 billion. Some of that is the result of investments that haven’t panned out. A lot of it is the result of liquidations following this year’s 8.6% loss for the fund, following only a 4% gain last year… a year in which it was difficult not to do well with stocks. Throw in 2016’s 13.5% loss and 2015’s 20.5% dip, it’s not difficult to understand why yet-another poor start to the year has rattled investors. This isn’t supposed to happen to hedge funds, which – theoretically anyway – hedge against this kind of adverse volatility.
It does happen though. Indeed, it happens to even the best of traders.
Actually, that’s not entirely true. It doesn’t happen to “the best of traders” because the “best of traders” don’t let themselves fall into the trap Ackman fell into. In that it never hurts (and is usually cheaper) to learn from someone else’s mistakes though, a reality check of what went wrong for Pershing Square might be a good exercise for anyone that’s more than merely passive when it comes to stocks.
1. Failure to accept defeat
First and foremost (and anyone reading this likely knows it already), Pershing Square’s chronic losses are almost entirely attributable to two trades. Those are, a short trade against Herbalife, and a long trade on Valeant. He ended up suffering a $3 billion loss on Valeant, riding shares from an entry price of around $154 per share to an exit price somewhere near $12… a decline that lasted about a year, and didn’t unfurl all at once. Ackman’s loss on Herbalife was about half a billion bucks, with the stock losing ground for the better part of the five years he held the short position.
Calling a spade a spade, his losses got in his head, and he convinced himself everything was going to be fine when it clearly wasn’t.
In his defense, it’s not an entirely shocking outcome. While most traders don’t tout their losses – or even their positions – Ackman wasn’t just financially committed, he was publicly committed. Pershing Square shareholders were, if nothing else, looking for confidence in him. He had to dish it out.
Nevertheless, the “it’ll come back” justification has killed more trading careers than anyone cares to think about. “It” rarely comes back. Cutting losses early is crucial to your survival, and a disciplined stop-loss plan is the best way to make that happen.
2. Assumption that what worked in the past will work in the future
Bill Ackman isn’t a dumb guy. He knows quite well how this game works. He bluntly said in an interview late last year that “It’s hard to make a lot of money if you’re doing what everyone else is doing.” He just forgot his advice.
Several years ago – several – “activist” speculation wasn’t a thing. It was relatively unusual, though not unheard of, for a hedge fund or activist to publicly shame a company as Ackman sought to shame Herbalife. When he first started doing it, it was rare, traders took notice and was able to push a stock lower.
Taking their cue from Ackman and a few others though, the war of words he relied on lost its potency, as investors heard them so often they became numb to them. The ploy stopped working because too many other activist investors, most of which were hedge funds as well, were doing the same.
That said, it wouldn’t be unfair to also add to the mix how Herbalife wasn’t exactly the easy target Ackman felt it would be. Sloppy trade selection stemming from a few too many other successes set the stage for the bad trade… a trade he likely wouldn’t have made just a few years prior.
For traders, it’s not just a tactic that may come and go in effectiveness. A public-participant market is always in flux, and the tools or indicators that worked at one time won’t always work as well in the future.
3. Betting too big on one trade
Finally, it may be (painfully) cliche, but Ackman simply bet too big on too few bets. Herbalife, Valeant and Chipotle were all arguably too much of his portfolio, making them all-or-nothing positions… more or less.
Sure, if you want to win big you have to bet big. But you don’t actually have to bet big to win big, particularly when you run the risk of losing big. More-but-smaller trades at least gives you a fighting chance of sidestepping trouble should trouble arise. It also gives you more buy/sell flexibility. Ackman once lamented that he couldn’t buy or sell stakes in those companies because his positions in them were so large, he’d move the market.
By spreading things out a little bit, at the very least he could have made reasonable adjustment to adapt to the market. After all, three out of four stocks move in the same direction as the overall market does, regardless of that stock’s underlying value.
Though Bill Ackman may be down, he’s not yet out. While some Pershing Square investors are fleeing, some are toughing it out, and many investors understand that hedge fund managers, like the market itself, are cyclical. He’s got too much of a name to simply fade away now.
He’s still human though, and prone to mistakes… just very costly mistakes that most traders can’t envision. Better to learn from him than learn them for yourself.