Ackman Scored $2.6 Billion on Bond Bets as Markets Sank

Activist investor Bill Ackman almost bailed out of the capital markets in the face of stocks’ coronavirus-driven rout, but he chucked that idea to make a savvy bearish bond-based bet on the slide—a move that bagged him a $2.6 billion profit.

Initially, fear over the baleful impact of COVID-19 led him to consider, “for the first time ever, liquidating the portfolio in its entirety because we believed it was likely that markets would decline materially,” Ackman wrote in a letter to investors in his company, Pershing Square Capital Management. That meant both stocks and bonds.

Then he changed his mind: “After a careful review of the portfolio, we concluded that a hedging strategy was more consistent with our long-term ownership philosophy and would likely lead to a better long-term outcome than selling off all of our assets.”

To protect the portfolio against the coronavirus’s economic impact, Pershing Square paid about $27 million for the hedges, buying credit protection on investment-grade and high-yield indexes, Ackman said. The hedges, in the form of credit default swaps, generated $2.6 billion in proceeds by the time he exited them on March 23.

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From early March to March 23, when the rescue effort from Congress and the Federal Reserve took shape, investment-grade bonds lost 6.2% and junk bonds were down 19.7%, data from Bloomberg Barclays Indices show. A credit default swap is a derivative that, in effect, allows an investor to bet that certain fixed-income securities, in this case these two classes of corporate bonds, will drop.

At their apex, Ackman indicated, the hedges amounted to about 40% of the firm’s total capital. The upshot: The company generated 11% on its investments last month, according to its website.

The stock market turnaround and a bond price recovery led him to unwind the hedges after March 23, he wrote. He said he was encouraged by a “much more favorable risk-reward ratio” in shares Pershing bought cheaply during the market plunge.

Among shares he added were those in Warren Buffett’s Berkshire Hathaway conglomerate, coffee chain Starbucks, and home improvement retailer Lowes. He said these are “essential businesses” that will do well even if there’s another virus-related plunge.

Last month, saying “hell is coming” if drastic moves weren’t implemented, Ackman called for a 30-day nationwide shutdown to impede the outbreak’s spread. But with the Washington rescue taking form, he then grew encouraged and bought the stocks (some of which he already had positions in, such as Berkshire).

“While it is hard to be positive when we know that tens of thousands more will die and many more will get severely sick,” he added, “I have no choice but to be more optimistic about the intermediate future based on the data and facts I have seen recently. I hope I am right.”

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Tags: Bill Ackman, Coronavirus, Hedge Fund, Pershing Square, Stocks

New York University (NYU) has issued a report saying the New York City Teachers’ Retirement System’s (TRS) funding concerns, which are being amplified through the economic distress caused by the COVID-19 pandemic, threaten to become a significant stimulant to a “fiscal and political crisis” in the city.

NYU claims that two distinct attributes of the TRS—a relatively conservative contribution policy, whose rates rise when the pension’s funding ratio falls, and a Tax-Deferred Annuity program—pose a great risk to the city.

The basis for the report was the extreme volatility in public exchanges caused by the pandemic, the effects of which would be magnified by the two aforementioned qualities of the pension, which was last reported to be approximately 74% funded.

TRS’ Tax-Deferred Annuity program pays out a fixed rate of return, typically set at 7% by the state legislature, backed by the defined benefit pension fund and subsequently taxpayers and the city budget. If, in any given year, the pension’s actual return profile exceeds the 7% target, the excess funds above the rate are housed within the pension system.

However, if the return profile falls short of 7%, as can be expected after the recent market downturn, the pension fund is responsible for shoring up the difference, meaning more strain on the city budget.

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“The TDA fixed-return fund had $24 billion in assets in 2018, so a shortfall of 5%, for example, would require the defined benefit pension fund to make up approximately $1.2 billion to the TDA,” the report said.

“The guarantee provides valuable benefits to plan members but creates special risks to the city,” the report said. “It does not have the constitutional protection that the regular retirement benefit has and therefore is more directly under the control of state and city policymakers.”

The university conducted a few studies using the pension’s 7% return baseline scenario, and found that the TRS poses substantial contribution risks to the city budget. The university estimated there’s a 20% chance the contributions will rise above 60% of payroll within the next 30 years, citing that there’s almost a 50% chance of severe underfunding to the pension within that timeframe.

The university said if the system did away with the Tax-Deferred Annuity program, the risk of it becoming severely underfunded within the next 30 years drops to just 2%.