Bill Ackman (Trades, Portfolio) and his hedge fund, Pershing Square, have made headlines multiple times over the last several months. From booking a profit of around $2 billion by shorting the market just before it reached a bottom to consolidating his position in Starbucks Corp. (SBUX, Financial) during a period when restaurant sales were plummeting, there have been very interesting moves by Ackman. In his latest move, the guru exited his investment in Berkshire Hathaway Inc. (BRK.A, Financial)(BRK.B, Financial), which was revealed during a conference call with investors on May 27. According to data from GuruFocus, Ackman’s investment in Berkshire had a value of around $1 billion and accounted for 15% of the total portfolio.
Source: GuruFocus
This decision has left many investors baffled as Ackman has long praised Warren Buffett (Trades, Portfolio) for his astute investment decisions. A closer look at Pershing Square’s investment strategy, Ackman’s past comments and Ryan Israel’s recent explanations give a better idea about the decision to sell the stake in Berkshire.
The guru’s comments in 2019
A good starting point to this analysis is understanding the reasons behind the guru’s initial investment in Berkshire's Class B shares last year. According to data from Pershing Square filings, the hedge fund bought the bulk of its shares in the conglomerate during the second quarter of 2019. In an interview with Yahoo Finance last August, Ackman said:
“The catalyst for our current investment in Berkshire is our view that the company is currently trading at one of the widest discounts to its intrinsic value in many years, at a time when we expect the operating performance of its subsidiaries to improve as a result of certain managerial and organizational changes at the company.”
Pershing Square added to its position in Berkshire in the first quarter of the year as well amid the market selloff.
The decision to liquidate the investment is unlikely to have made based on the current valuation multiples. For instance, the price-book ratio of the Class B shares has declined since the second quarter of 2019, which implies they are still attractively priced.
To get more color on Ackman’s recent sale, an investor should pay attention to one of his right-hand men.
A Pershing Square insider’s view of the recent sale
Ryan Israel, a partner at the hedge fund, is widely believed to have overseen the decision to invest in Berkshire last year. During the investor call on May 27, Ryan said:
“We think it’s a very different environment than when we made the investment in Berkshire a year ago. We continue to think Berkshire will be a strong investment over the long term, but we also think the current environment means there may be more than typical opportunities for us to see very high-returning investments.”
This statement provides some insight into the decision to sell shares of Berkshire. In mid-2019, American markets were soaring to new highs and there were not many opportunities to choose from. Therefore, many investors were forced to hold cash or invest in low-risk businesses such as Berkshire. However, as Ryan noted, the current macroeconomic situation is very different. Cyclical stocks are still reeling from the losses of the current economic downturn and a prudent investor is bound to find very attractive opportunities in these battered and beaten stocks. Such stocks will arguably deliver the best investment returns in the coming years. For an active investor of Ackman’s caliber, it’s only natural to allocate assets to these lucrative opportunities.
Pershing Square’s strategy makes it difficult to hold Berkshire shares while searching for new investments
An investor might believe that Ackman could have held on to his investment in Buffett’s conglomerate while betting on other bargain opportunities in the market. However, a closer look at his strategy reveals that this is not possible.
First, Pershing Square’s objective is to invest in the best eight to 12 investment ideas it comes across at any given point in time. This concentrated approach helps the fund bet on the most attractive opportunities rather than diversifying the portfolio unnecessarily. Even if a company seems to be undervalued, there’s always the risk of it being removed from the hedge fund’s holdings when a new company becomes even more attractive. This might have been one of the biggest reasons for the guru to dump Berkshire shares.
Second, Pershing Square is a hedge fund that takes on a considerable amount of risk to generate high returns. The Key Information Document of the fund confirms this.
Source: Key Information Document of Pershing Square.
The high volatility in today’s markets presents many bargains for risk-seeking investors, and Berkshire does not fall into this category. Ackman’s search for alpha returns by betting on risky investments might also have played a role in his decision.
Third, Berkshire’s massive cash pile of around $130 billion is seen as a limitation for the growth of the conglomerate by many analysts, and Ackman shares this view as well. As an activist investor, the guru likes to put money to work. During the investor call, he said:
“The one advantage we have versus Berkshire is just relative scale. Berkshire has the problem, if you will, of deploying $130 billion of capital or some fraction of that number is still a very large number relative to the liquidity available in buying one equity at a time.”
In other words, Ackman believes his fund is in a more advantageous position to make the most of the volatility in the market than Berkshire, which needs to find elephant-sized acquisition targets. It’s reasonable to assume this could have played a role in his decision.
Takeaway
A deeper dive into Ackman’s recent sale of Berkshire Class B shares reveals the guru does not think Buffett’s conglomerate is overvalued. Rather, this seems to be a tactical asset allocation decision, suggesting there are better opportunities in the market. However, many of these bargains are likely to be high-risk, high-reward investments, which might not be suitable for a retail investor. It’s important to draw a line between what works for a hedge fund and for an individual investor whose objective is not to beat the market. Berkshire Hathaway investors, therefore, need not be alarmed about Ackman dumping shares.
Disclosure: I do not own any stocks mentioned.
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