By: Steve Smith
Hedge Fund manager, Bill Ackman, isn’t known for keeping a low profile or being bashful about talking about his book. Over the past two decades, his Pershing Square fund had some amazingly successful trades which reap large profits and has also suffered high-profile losses.
The day after Netflix’s (NFLX) stock crashed some 36%, following a bad earnings report, Ackman revealed that his firm had dumped every share they owned, incurring a $435 million loss. Ouch. The stake in NFLX was established, with great fanfare, just 4 short months ago. It made Pershing the second-largest shareholder, behind founder Reed Hastings, in the streaming company. When word of Ackman’s investment came to light in early February, NFLX shares popped some 13$.
This incident can offer us, mere trading mortals, some valuable lessons.
The Pershing Square fund has a very concentrated portfolio of just 17-20 investments at any given time. Often, Ackman and his firm are the largest shareholders of any given company he’s involved in, usually with a long-term time horizon. This means that he brings very strong and deeply held convictions on how these companies should be run.
In two prior missteps, such as the large stake in run-down retailer JC Penny (JCP) he had a master plan to overhaul the also-ran discount retailer by creating “stores with the store” and doing away with promotions and discounts. Ackman brought in new management and spent billions on refurbishing stores and launching a new marketing campaign. But, after four years with little improvement in the chain’s performance, Ackman walked away in 2014 with his firm suffering a $600 million loss.
A more contentious play was Ackman building a large short/bearish position in Herbalife (HLF), the multilevel marketing healthcare product company. He contented that Herbalife was a scam and he was determined to undercover their misdeeds to ultimately put them out of business. And just to show this was about him being a deep-pocketed Wall Street predator, Ackman promised to give all the profits to various charities.
Ackman’s grandiosity seemingly rubbed some other hedge fund titans the wrong way, specifically, Carl Icahn, who got into a shouting match with Ackman on live T.V. The discussion devolved into schoolyard name-calling with Icahn telling Ackman “he had no friends.” But, he apparently had enemies that were willing to put their money where their mouth was. Soon, there was a concerted action of buying HLF shares and call options, sending HLF up some 60% within a couple of weeks. Ackman hung for about a year before throwing in the towel and taking a $450 loss. One lesson Ackman learned from the HLF incident is “do not broadcast your short positions!” It leaves you in a very vulnerable position where the competition will create a squeeze you can’t control.
I discuss these two high-profile incidents because, in both cases, Ackman seemed to let his ego cloud his judgment and make critical risk management mistakes. In JCP and HLF, he felt he knew better to the point, seemingly making a morality statement. He became involved in both those businesses at a very personal level.
This wasn’t the case with NFLX. Ackman liked the management and thought they could navigate through a changing and competitive landscape; just as they did with the transition from DVDs in the mail to streaming.
But, the earnings report clearly showed they didn’t have a firm grip on their situation or present a cohesive plan for regaining a growth trajectory.
In my opinion, Ackman made a tough but smart decision by ripping the bandaid off and taking the loss in the here and now. For that, he should be commended.
The mantra I preach here in the Options360 Concierge Trading Service is; Find a set-up with well-defined parameters. If something changes for the worse, risk management must be implemented with no hesitation and no mercy. Anyone who has been in this business knows that losing trades/investments are simply part of the game. Wins and losses do not define who you are as a person. It’s how you handle adversity that shapes you, which will lead to your ultimate success. After all, trading and making money is just a means to end to allow you build a life outside of the screens.