The fund that will profit from higher yields

Listed hedge fund Pershing Square Holdings (LON:PSH) has protected its portfolio against the threat of higher Treasury yields caused by rising inflation. 

Last week was a fascinating one for investors with medium and long-term US Treasury yields spiking sharply higher. This prompted a sell-off amongst longer duration assets like some of the growth stocks whose valuations would be particularly vulnerable to an increase in interest rates. 

If the trend continues it would represent a seismic change in the markets and would indicate a growing consensus that the monetary and fiscal stimulus coupled with the end of lockdown would lead to a surge in inflation. Jerome Powell, the chairman of the Federal Reserve, has played down the risk saying that any increase will only be transitory, but the authorities are desperate for inflation to erode the real value of their debts and are perfectly happy to let it run hot as long as it doesn’t destabilise the system. 

Global stock markets have benefited from low yields ever since the financial crisis in 2008 and many of the elevated valuations can only be justified by applying depressed discount rates to their future cash flows. Any significant increase could easily lead to a severe and widespread correction, hence the weakness last week. 

Hedging the risk

Most funds would be vulnerable in this sort of scenario, but the £6.9bn investment trust Pershing Square Holdings (LON:PSH) has actively sought to profit from it so as to protect the value of its portfolio. According to the Telegraph, PSH’s billionaire founder, Bill Ackman, has bought ‘instruments that pay off in a large way in the event of a surprising move in rates’.

“We will see a spike in inflation as early as the middle of the year. It is already starting to happen. At some point if rates move enough then it becomes a market risk event,” he said. 

PSH has invested a finite amount of money that it can lose, but which is not material to the fund, in order to act as disaster insurance. If interest rates move as envisaged the policy would ‘make a lot of money’ and protect the portfolio against such a potentially huge market-moving event. 

He has done it before

Ackman took a similar step ahead of the pandemic when the fund bought out-of-the-money protection in the credit markets that it was then able to cash in and invest at the height of the sell-off. This enabled the shares to bounce back within a matter of days and go on to make an 80% return in 2020. 

PSH has an incredibly concentrated portfolio of just ten stocks that it tends to own for the long term. These are large, durable, growing companies that are well-placed to benefit from the end of lockdown and include Lowe’s, Chipotle Mexican Grill, Hilton Worldwide, Restaurant Brands, Howard Hughes and Starbucks. 

PSH is a unique vehicle and has an excellent record in recent years, yet the shares trade on a persistently wide discount to NAV that currently stands at 29%. It could be one of the few ways to benefit from the end of lockdown without running the risk of a catastrophic loss as a result of resurgent inflation.