One of the classics of investment literature was written in 1955 by a man named Fred Schwed Jr., a disillusioned former Wall Street trader turned children’s book author. Drawing on his Wall Street experience, Schwed wrote a scathing indictment of all the ways investment advisors separated clients from their money. It was titled, “Where Are the Customers’ Yachts?”
Bill Ackman’s revelation that he had dumped his stake in Valeant Pharmaceuticals International Inc. after it had dropped from $260 to $11 in the space of a year and a half — and, according to Bloomberg, cost Ackman’s hedge fund more than $4 billion — has already provoked a good deal of excellent commentary. My Bloomberg View colleague Barry Ritholtz pointed out that it exemplified Ackman’s lack of consistency as an investor, while Matt Levine noted that Valeant, with its postmodern approach to drug pricing and earnings growth, was the perfect sucker’s bet for a postmodern fund manager like Ackman.
But there’s at least one more question hanging over the Valeant debacle: “Where are Ackman’s customers’ yachts?”
The typical hedge fund has two different income streams: a management fee and a performance fee. This fee structure is encapsulated in the phrase “2 and 20,” meaning that the fund takes 2 percent of its assets each year for managing the fund, plus 20 percent of any profits (the performance fee).
The fees charged by Ackman’s fund, Pershing Square Capital Management, have been slightly lower than the norm: a 1.5 percent annual management fee and performance fees that have ranged up to 16 percent, depending on the fund. (Pershing Square manages four different hedge funds.)
Although Pershing Square’s overall performance has been quite good since its inception in 2004, Ackman’s track record is littered with huge bets that went bad. In 2007, he set up a $2 billion fund specifically to target, er, Target. It crashed spectacularly. In 2010, Ackman bought 39 million shares of J.C. Penney Company Inc., got a seat on the board, brought in a new chief executive, got rid of that CEO a few years later, got off the board, and sold his shares for a loss of over $600 million.
The J.C. Penney fiasco badly hurt Ackman’s performance in 2013. Though the S&P 500 was up 32.9 percent, Pershing Square only rose 9.6 percent. Even so, the fund by then had $11.2 billion of investors’ money, which, if you do the math, would suggest $168 million in management fees. (Pershing Square says that the amount is lower because it does not take management fees for the approximately 8 percent of the fund that consists of its employees’ money.) In addition, even though Ackman woefully underperformed the market, his firm still claimed a performance fee since it generated a positive return; I estimate that to be in the $140 million range. Thus Pershing Square and Ackman reaped, conservatively, nearly $300 million for a pretty dismal result.
In 2014, however, Ackman did something brilliant. No, I’m not talking about his investment in Valeant, which went up that year. Nor am I talking about his investment in Allergan Plc, which he loaded up on early in the year, and then acted as a “co-bidder” with Valeant in a takeover attempt — an effort that ended when Activis rode in as Allergan’s white knight. Ackman wound up with a $2.6 billion gain when he sold his Allergan stock.
What I’m talking about is his decision, that October, to take public a closed-end fund that was designed to track Pershing Square’s performance. It was called Pershing Square Holdings Ltd, and the IPO raised $2.8 billion. By the end of the year — a year in which Pershing Square Holdings was up over 40 percent, thanks largely to that Allergan takeover play — investors had nearly $18.3 billion with Bill Ackman’s funds. Go ahead, do the math: 1.5 percent of $18.3 billion is $274.5 million. Deduct some of that because of the employees’ assets, and it was still in the $250 million range. And the performance fee was around $700 million. CNBC reported that December that “Ackman was poised to pull in at least $1 billion” in compensation.
The disadvantage of having a publicly traded closed-end fund is that, whether you have a good year or a bad one, you have to report your performance to the public. The advantage, however, is that the money residing in that fund is permanent capital — it can’t be withdrawn by investors who want out because, say, they are upset with poor performance. Ackman buttressed that permanent capital with a $1 billion bond offering.