09/23/2009

Pershing's Ackman Admits Investing Errors

William Ackman, founder of Pershing Square Capital, pulled no punches last week in admitting to investors that he misplayed the market in the second quarter.

His Sept. 18 letter to investors was a surprisingly harsh mea culpa considering the returns that his hedge funds produced were less than shameful. His two main funds, Pershing Square 1 and 2, gained around 7% each in the April-June stretch. Pershing Square International rose 8.2% during the same period.

Still, those results were far worse than the 16% gain in the S&P 500 index in the second quarter and the 20% jump in the Nasdaq index. Discussing that shortfall, Ackman beat himself up in writing, admitting his firm was guilty of "errors of omission" for missing out on buying opportunities as stocks surged during the second quarter.

"Because I believe that owning up to one's mistakes in a public fashion decreases the probability of those errors reoccurring, I do so here," he wrote. His firm had $6 billion of assets at the end of 2008.

As a stock picker, Ackman is known for taking concentrated positions based on extensive research. In his 10-page letter, he acknowledged the strategy has its limitations during a bull market.

"We have always believed in managing a concentrated, high-conviction portfolio that requires detailed, in-depth and oftentimes consuming analysis," he wrote. "The benefit of our approach is that once we find an investment that is extraordinarily attractive, we can confidently invest a meaningful percentage of our capital. The downside is that if security prices are rising quickly, we will miss some opportunities."

During the second quarter, Ackman said, Pershing missed some investment opportunities altogether, while in other cases the New York firm wasn't aggressive enough in acquiring sizable stakes. "Unlike many investors, we do not take token positions as we begin work and then add to positions as we build conviction," Ackman said. "We are either all-in (while often retaining a 're-buy' ticket in our pocket), or we keep our chips in a large pile of U.S. Treasurys."

There were also some "unforced errors," when Pershing failed to hold positions long enough. A case in point: Pershing sold its stake in Cadbury during the second half of 2008 because it believed the credit crisis made it highly unlikely that the world's No. 2 candymaker would be sold. This month, Kraft Foods offered to buy Cadbury for $16.7 billion - a 42% premium over Cadbury trading price before the deal was announced. And analysts expect Kraft ultimately will have to offer significantly more to get the deal done. Ackman admits his firm blew it on the Cadbury trade, underestimating the speed with which financial markets would recover. The mistake was especially painful because Pershing had earlier correctly identified Kraft as a likely buyer.

Pershing did manage to score some hits during the second quarter. Ackman's large, high-profile positions in retailer Target, technology company EMC and mall REIT General Growth Properties gained substantially, helping push his funds higher. In addition, some credit-default swaps were hugely profitable.

Pershing Square 1 was up 9% through May, while Pershing Square 2 gained 7.5% during the first five months of the year. Pershing Square 1 lost 13% last year following a 22% gain in 2007. Pershing Square 2 dropped 11% in 2008 following a 29.5% gain the year before.

Ackman also used his letter to spell out a number of steps his firm is taking to improve transparency and better protect assets. Pershing has hired UBS as a second prime broker to supplement the services of its lead prime broker, Goldman Sachs. Ackman said Pershing talked to eight banks, narrowing the field to three finalists before selecting UBS. Since the collapse of Lehman Brothers one year ago, a number of hedge fund managers have moved to diversify their prime-brokerage services so as not to have too much exposure to one investment bank.

Ackman also announced that Pershing's third-party fund administrator, Morgan Stanley, will begin providing monthly asset verification, reporting directly to investors. Separately, Pershing has agreed to provide certain portfolio data to Measurisk, a J.P. Morgan unit, which will allow investors to better gauge the risks and exposure of their portfolios, Ackman said.

Finally, Ackman announced two hires: Rob Unger joined Pershing's trading operation from SunTrust, and Steve Symonds came aboard from Man Investments to work on client relations and investor outreach.

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