Pershing Square Holdings has generated impressive returns, yet it divides opinion and could be on the cusp of a major re-rating.
The £7bn Pershing Square Holdings (LON:PSH) is one of the most interesting investment trusts on the market. It is managed by activist investor Bill Ackman who takes concentrated and influential positions in large, liquid US stocks that he thinks are undervalued by the market.
PSH has just released an impressive set of accounts covering the first six months of the year in which it generated a NAV total return of 28.9% compared to a loss of 3.1% in the S&P 500. Year-to-date (to 25 August) it is up 44.1%, versus a gain in the benchmark of 7.9%.
Strong performance of this sort of magnitude would normally push the shares onto a premium rating, yet they have persistently traded at a wide discount which currently stands at 25% despite having a sizeable share buyback programme in operation. The recent gains have put it within touching distance of promotion to the FTSE 100 index, which could provide the catalyst for a major re-rating.
Active management at its best
Ackman wrote about the threat posed by the coronavirus in the 2019 annual report and put in place hedging positions in the credit default swap markets to protect the portfolio. These generated significant profits in March and were then quickly unwound with some of the proceeds used to top up the existing core holdings as well as to open a new position in Starbucks.
PSH’s strategy is to acquire ‘small pieces of superb businesses over which they have substantial influence’. At the end of June they owned minority interests in ten portfolio companies, including: Chipotle Mexican Grill, Hilton, Lowe’s Companies, Restaurant Brands International, Starbucks, Howard Hughes Corporation and Fannie Mae.
In July the investment manager raised $4bn of external capital for a special purpose acquisition company that will be used to buy a significant minority stake in a large private business which fits the manager’s investment criteria. PSH invested around $60m to purchase sponsor warrants that will become ten-year warrants on just under six percent of the newly merged company shares if a transaction is successfully completed. These provide significant additional upside potential to the portfolio.
Ackman remains bullish, as you would expect, and does not believe that the coronavirus has permanently impaired the intrinsic values of his holdings. He actually takes the opposite view and thinks that the economic, behavioural and competitive effects of the virus, along with the portfolio companies’ actions in response to it means they are well placed to generate strong returns in the future.
It is very unusual for an investment trust that holds liquid assets to trade on a 25% discount, especially given the large share buyback programme. The most likely reasons include the highly volatile returns that put off many investors; the significant borrowings that could limit the manager’s ability to buy back more shares; and the high fees that further undermine the demand.
Perhaps the best chance of turning things around – other than the continued strong performance − is the possible promotion to the FTSE 100 index. All other things being equal, PSH would only need to increase its market value by 16.6% to qualify for inclusion. If this were to happen it would boost the demand for the shares amongst the tracker funds linked to the index.
The analysts at Numis have recently added Pershing Square to their recommended list as a trading buy because of the excessive discount. They highlight the outstanding performance record and although they acknowledge that some of the holdings are exposed to increased restrictions on movements, they take comfort from the fact that the manager believes they are attractively valued and are well placed to generate strong returns.
Ackman has successfully hedged the portfolio in the past and would potentially do so again if the need arose. As long as you are comfortable with the high volatility and can stomach the fees, it might be worth a punt as the fund and some of its holdings remain stubbornly out-of-favour.