Pershing Square Holdings, Ltd. Provides Update to Investors

LONDON–(BUSINESS WIRE)–Regulatory News: Pershing Square Holdings, Ltd. (LN:PSH) (LN:PSHD) (NA:PSH) today noted that Pershing Square Tontine Holdings, Ltd. (NYSE:PSTH) CEO Bill Ackman issued the following letter.

Q2 2022 hedge fund letters, conferences and more

To the Shareholders of Pershing Square Holdings, Ltd.: 

In the first half of 2022, Pershing Square Holdings generated NAV performance of negative 26.0%, and a slightly lower  total shareholder return of negative 27.3% due to the widening of the discount to NAV at which PSH’s shares traded.5  PSH’s year-to-date NAV return through August 16, 2022, was negative 10.8% compared to negative 8.8% for the S&P 500  index over the same period.6 

The Year to Date 

2022 has been an unusual and highly volatile year in the capital markets. This volatility has been driven by uncertainty  associated with high levels of global inflation, central-bank-led increases in interest rates and related confusion about  monetary policy, the risk of a possible recession, the war in Ukraine, political divisiveness and discord, and fear and unease  about climate change and geopolitical risk. Each of these factors on their own could be a cause for a high degree of stock  market volatility. When combined, uncertainty and volatility rule the markets. 

Our approach to investing capital is to find extremely durable, well-capitalized, high-quality growth companies that can  survive any storm. If we are successful in our investment selection, we can largely ignore shorter-term factors that drive  stock market movements and remain focused on our portfolio companies’ underlying business performance. As long as  

our companies continue to deliver the results we expect, we do not need to make any material adjustments to our portfolio’s  composition. In other words, we can sail through the stormy seas with a focus on the long-term horizon. 

We don’t, however, ignore global events that create risk and uncertainty. While we try to consider every potential risk  that could impact our portfolio companies and invest in businesses that can withstand these risks, the world is and will  remain a highly uncertain place, so a high degree of vigilance will always remain appropriate. Staying knowledgeable about  global macro and political events is important for assessing risk for our portfolio companies and in selecting new company  investments. It also occasionally offers opportunities for profits from carefully selected hedging transactions. 

One of our strategy’s important competitive advantages is our ability to profit from unanticipated market events enabling us  to generate large profits and liquidity from hedges during periods when equity prices are likely to decline substantially. Our  investments in: (1) index and single-name credit default swaps before the Great Financial Crisis, (2) investment grade and  high yield index CDS in the weeks prior to Covid impacting the markets, and (3) interest rate swaptions in late 2020 to the  present day in light of our concerns that interest rates would rise more quickly and remain at higher levels than anticipated,  are all good examples of the importance of our understanding and foreseeing the impact of global macro risks and hedging  them when we can identify an asymmetric means to do so. 

If It Is So Obvious, Why Doesn’t Everyone Do It? 

While our approach to investing capital is logical and straightforward and has a long-term outperformance record, it is the  rare investment manager that can implement such a strategy. Many of our colleagues in the industry have told us that they  would prefer to invest as we do with their own money, but that their investors’ demands effectively prohibit such an approach.

While many investors in funds claim to be long term, they require short-term liquidity from their managers. When managers  oversee funds that can be withdrawn on short notice, they generally have no choice but to manage for the short term.  Furthermore, most investors in funds are fiduciaries who are themselves held to short-term measurements of their own  performance. So when the inevitable period of underperformance occurs due to broad-based market movements or otherwise,  investors in funds redeem their capital, and their managers become forced sellers. 

The inherently short-term nature of the investment management industry is a large contributor to stock (and bond)  market volatility. As many funds suffered substantial drawdowns earlier this year, they sold stocks to raise capital to meet  redemptions, and reduced market exposure as their risk appetites declined. This pattern of reducing equity market exposure  as stock markets decline occurs in every market disruption, but it is precisely the opposite of what long-term investors  should do. It is axiomatic that the lower the price paid, the better one’s long-term returns. Yet, in each crisis and/or market  drawdown, fund managers sell and reduce exposures, rather than increase exposures at more favorable valuations.  

The inverse is also true. Investors in funds generally commit more capital when funds are generating strong absolute  performance. During the ebullient market which preceded this year’s decline, investors committed more capital to funds  which put the money to work at higher valuations. Investments at higher valuations are destined to generate lower returns. 

Pershing Square Holdings’ closed-end fund structure and large insider ownership provide us with the ability to be a truly long term investor in a world where the vast majority of fund managers are constrained to a shorter-term approach. Our long term investment approach is one of our most important competitive advantages and a major contributor to our substantial  outperformance over the last nearly 19 years.7 We believe that our even larger outperformance since early 2018 can be  explained by our transition from a manager of shorter-term redeemable assets to a manager of effectively perpetual assets. 

Today, substantially all of Pershing Square’s assets under management are in PSH or represent capital invested in our private  funds by affiliates of the investment manager.8 The permanency of our asset base allows for a truly long-term investment  approach. We have not raised any net new equity capital in years so we are not exposed to the risk of raising capital at market  peaks. Furthermore, we have been active in periodically returning capital when PSH is trading at a ‘double discount’ by  repurchasing PSH shares opportunistically when our portfolio companies are trading at attractive valuations and PSH is  trading at a wide discount to NAV. Our estimate of today’s ‘proforma NAV,’ PSH’s NAV assuming our portfolio companies were  trading at their intrinsic value, is more than twice our current share price.9 

Our effectively perpetual capital is also a great recruitment tool for talent. The universe of firms where one can go to invest  permanent capital is extremely small. For all of the above reasons, the most talented investors prefer to work for a firm that is  able to implement a long-term investment approach. 

Our closed-end fund structure is also a competitive advantage in allowing us to access low-cost, investment grade leverage in  the form of unsecured bonds without mark-to-market covenants on fixed rate terms. Of PSH’s total assets, 19% is funded by  long-term bonds with laddered maturities beginning five years from today until 2039 at a weighted-average interest rate of  3.1%.10 By using low-cost, long-term debt in place of one-fifth of our equity capital we have materially enhanced our ability to  generate high rates of returns without, in our view, any meaningful change in our risk profile. 

In summary, our closed-end fund structure is an enormous competitive advantage for how we invest capital, recruit talent,  and raise low-cost and low-risk unsecured bond leverage. It has, however, come with one negative externality. In recent  years, PSH has traded at a large discount to its NAV.

Discount to NAV 

In a private fund or in an open-ended mutual fund which invests in liquid assets, investors are guaranteed to receive the net  asset value of their holding when they redeem. The same is not true for a closed-end fund as investors are exposed to the risk  that a closed-end fund’s share price trades at a greater discount to NAV when they exit than when they originally purchased  their shares.  

Since late 2015, the beginning of a several-year period of underperformance, PSH began trading at a large discount to NAV  which has widened over time. While this discount is an advantage when we buy back our shares, it is a disadvantage to a  shareholder when they decide to sell. The substantial majority of our shares are owned by investors who purchased PSH at a  discount to NAV which helps to mitigate the negative impact of the NAV discount on their returns. As long as one sells PSH at  a similar discount to that when the shares were purchased, one’s return will approximate PSH’s underlying NAV performance. 

Our discount has persisted despite best-in-class performance and the aggressive steps we have taken to address it: 

• Based on Bloomberg data (please see Appendix A), PSH has the best five-year NAV return of the 100 largest closed end equity funds in the world, which includes funds ranging from $774 million to $16.6 billion in net asset value. 11
• PSH became a premium listed company on the LSE on May 2, 2017 and joined the FTSE 100 on December 21, 2020,  which has led to increased index inclusion and demand for our shares.  
• With the benefit of some new director additions, we have a best-in-class, independent, extremely knowledgeable,  experienced, and diverse board. 
• Affiliates of the manager have acquired large amounts of PSH shares in the open market and now own 25.5% of the  company,12 which ranks among the largest inside ownership in the top 100 closed-end funds.  
• PSH has repurchased 22.5% of its shares outstanding since its IPO, a total of 54 million shares at a price of $17.32 and  an average discount of 27.1%. 
• PSH initiated a dividend in 2019, and earlier this year announced a new dividend policy whereby dividends will increase  over time with NAV. 

One would expect that with best-in-class performance and governance, the acquisition and ownership of more than one  quarter of the company by the investment manager, an aggressive and opportunistic share repurchase program and a  favorable dividend distribution policy, PSH’s NAV discount should have narrowed, but in fact the opposite has occurred. Why? 

The Supply of PSH Shares and Our Market Cap 

PSH’s discount to NAV is directly related to the supply and demand for PSH shares. With respect to the supply of shares,  the number of PSH shares has decreased due to buybacks by 22.5% since our IPO. Acquisitions of shares by affiliates of the  investment manager reduced our public float by an additional 39 million shares or 16.3%,13 a 39% cumulative reduction in our  public float since our IPO. PSH is the second largest closed-end fund in the world by NAV after Scottish Mortgage, and the  third largest by market cap. One might ask, therefore, whether there is a correlation between the market cap of a closed-end  fund and the discount at which the fund’s shares trade.

Is Size a Contributor to the Discount? 

Based on the Bloomberg data, there does not seem to be any correlation between the size of a closed-end fund and its trading  level relative to NAV. A number of the 15 largest closed-end equity funds trade at premiums to NAV, and the balance, other  than PSH, trade at single-digit percentage discounts. PSH has vastly outperformed the other top 15 closed-end funds as well  as the other 85 constituents over the last five years. PSH has outperformed 90 of the top 100 by more than 1,000 basis points  per annum. The median and average discount to NAV for the top 100 equity closed-end funds with greater than a $1 billion  market cap is 4% and 3% respectively compared with PSH’s current discount of 35%. 

Scottish Mortgage Investment Trust (“SMT”), the largest fund on the list by market capitalization, is an interesting point  of comparison. Despite its name, it like Pershing Square is a growth equity closed-end fund and also a FTSE 100 company.  SMT has a long and volatile investment history beginning in 1909. PSH has substantially outperformed Scottish Mortgage over the last one-year (6% vs -29%), three-year (27% vs 23% compounded annually) and five-year (24% vs 18% compounded  annually) periods.14 Yet SMT trades at a 6% discount to NAV versus PSH’s 35% discount to NAV. 

While PSH charges higher fees than most other closed-end funds largely due to our incentive fees, our NAV outperformance  record is net of all fees and expenses. PSH’s fee structure was not a barrier to raising $2.9 billion in PSH’s IPO, the largest IPO  in Europe in 2014, as the shares were sold at NAV and the fee arrangement was understood by all investors. We have no plans  to change our fees as our incentive and management fees are an important recruiting tool for our talent, who are responsible  for our substantial outperformance. Pershing Square recruits investment team talent principally from private equity firms  which also charge incentive fees. None of our investment team members would have joined Pershing Square and stayed if we  did not continue to earn incentive fees.  

There appear to be only three other closed-end funds in the top 100 that charge management and incentive fees. One of these  funds trade at a 10% premium to NAV and the other two trade at 12% and 19% discounts, which suggests that there is no clear  relationship between the fee structure and the degree of NAV discount or premium. 

Demand for PSH Shares 

While PSH is managed by a U.S. manager and principally owns North American headquartered companies, it trades only  on European exchanges, the LSE and Euronext Amsterdam. There are significant regulatory limitations in our ability to  market PSH in various jurisdictions, including the U.S, a more logical market for a North American-centric fund run by a U.S.  manager. Substantially all other closed-end funds that invest principally in North American equities are domiciled in the U.S.  and therefore do not have restrictions on marketing in the U.S. 

The rest of world demand for PSH has mostly been driven by dedicated closed-end fund investors and to a lesser extent index  funds that own the shares based on their index weightings.  

In summary, we have a demand problem compounded by certain marketing limitations. 

What Can We Do About It? 

There is no short-term solution to PSH’s discount problem. While a liquidation would eliminate the discount, offset somewhat  by frictional costs, it would also eliminate the long-term opportunity for PSH to generate high levels of compound annual  returns. We believe the long-term investment opportunity for PSH vastly outweighs the short-term profits that would come  from a liquidation.

We can, however, always do a better job marketing and informing investors about the existence of PSH. Despite the fact  that PSH is the 78th largest company by market cap on the LSE, and would be 51st on the list if it traded at NAV, PSH is still  relatively unknown by global investors. While Pershing Square, the investment manager, appears in numerous press articles  nearly every business day, PSH is largely absent from the media. Even considering our marketing restrictions, we can still do  more to inform investors about the existence of PSH and our investment opportunity. 

Could PSH Eventually List in the U.S.? 

As PSH grows in market capitalization and its ownership stakes in its portfolio companies increases, one can envision a world  in which over time PSH becomes a controlling owner of one of more businesses that comprise the substantial majority of our  assets and income. We expect to continually evaluate PSH and its operations, and consider whether in the future it may be  able to operate not as an investment company in the U.S., but rather as an operating company that could be listed in the U.S. 

How Should One Think about PSH? 

In economic substance, PSH is more akin to an investment holding company than a traditional passive owner of securities.  We are often the largest, or one of the largest owners of our portfolio companies, particularly if passive index owners are  ignored. We are known to be an active and engaged investor and often have board representation and/or considerable  influence in the board room as a large and thoughtful owner.  

Why Have Some Fund Managers Avoided Investing in PSH? 

While PSH is owned by many investment managers, we believe these investors are principally dedicated and or specialized  closed-end fund investors. Traditional investment managers often avoid investing in closed-end funds as they view doing  so as effectively their giving up investment allocation decisions to a third party and paying fees for them to do so. For many  years, many investment managers would not own shares in Berkshire Hathaway for similar reasons. 

Whether one invests in an operating company or a closed-end fund, however, ultimately the investor is giving up control  of capital allocation decisions to the management of the company. We do not believe that closed-end funds should be an  excluded asset class for that reason as long as the manager of the closed-end fund can generate attractive rates of long-term  performance, net of the fees it charges, that are competitive with returns from other public operating company investments,  with the caveat, of course, that the investors can’t simply replicate the performance of the closed-end fund by investing  directly in the same underlying securities. 

In our 2020 letter to shareholders (Link), we explain why PSH replication cannot be achieved by attempting to invest directly  in the same securities we publicly disclose. To summarize, this is due to three principal factors: 

1. Investors in PSH get the benefit of our new, undisclosed investments at the price they were acquired by PSH before  their eventual public disclosure impacts their price. Historically, the day-one trading price of our newly disclosed  stake in a company typically has been substantially above our cost of acquisition. PSH replicators must pay the  higher post disclosure price rather than our acquisition cost. These embedded gains inure to the benefit of PSH  shareholders, and to an even greater extent when PSH is purchased at a discount to NAV.
2. We do not disclose our hedging strategies in advance of their implementation. Our hedges have generated highly  material gains for PSH that are not readily actionable or replicable by most investment managers.
3. We are able to access long-term, low-cost investment grade debt without mark-to-market covenants, which materially reduces our cost of capital. Our access to covenant-light leverage is a difficult to replicate competitive advantage.

While many investment managers avoid investing in funds that charge fees, the effective fee burden of PSH has been largely  offset over time by our low-cost bond leverage (a weighted-average cost of 3.1%) that we have used in place of about 20%  of our equity capital. In other words, investors in PSH receive a similar long-term NAV return to what they would have  earned if they owned our underlying investments directly without leverage, as our use of bond financing roughly offsets our  management and incentive fees.

While some fund managers may choose not to invest in PSH because it is technically a closed-end fund, we believe that with  the passage of time and continued strong performance, our tax and regulatory structure will be viewed as a competitive  advantage and a reason to own PSH rather than a reason to avoid it. 

We chose the offshore closed-end fund structure for PSH with a full understanding of its marketing and other limitations.  We did so because we believed that the offshore closed-end fund’s favorable tax structure (with no entity-level taxation)  and investment flexibility versus other alternatives would give PSH long-term structural and competitive advantages in  generating high rates of return over time. 

Today’s extraordinary discount of 35% makes PSH’s investment proposition that much more compelling, and should hopefully  remove some of the traditional fund managers’ resistance to investing in closed-end funds. 

In summary, we believe that PSH is an excellent investment opportunity for both dedicated closed-end investors and the  much larger universe of traditional investment managers because the typical reasons for an investment manager not including  a closed-end fund in their portfolios don’t apply to PSH. We just need to do a better job getting the word out. 

Organizational Update 

The Pershing Square investment team is intentionally small. Currently, we have eight team members including myself, and  at peak, we had ten. The team operates extremely collaboratively. Each member of the team’s compensation is directly  dependent on the performance of the overall portfolio rather than individual investments. Research on new investments is  typically led by two members of the team, but vetted by the entire team. This structure has served us well over the years as it  has aligned everyone’s incentives with Pershing Square’s long-term goals. 

The team has operated in an entirely non-hierarchical format with one exception. As portfolio manager, I get to make the  final yes or no decision on investments and in determining the sizing of positions. With the benefit of effectively no turnover  in the team over the last five or so years, our investment team is the most highly functioning it has ever been.  

I periodically get asked about succession planning at Pershing Square. At age 56, loving what I do and in excellent health,  my principal risk is what can be deemed “pie truck risk,” that is, the risk I look the wrong way crossing the street and get  smooshed by a pie truck.  

As a manager of perpetual capital, I am obligated to give some insight to our shareholders as to how we would operate if the  pie truck ended my existence. I don’t believe in a committee approach to investing where a majority vote determines each  portfolio decision. At the end of the day, someone needs to make the decision and be held accountable.

I am pleased to announce that Ryan Israel, who joined Pershing Square from Goldman Sachs in March of 2009, will now  become our Chief Investment Officer. I will continue as CEO and Portfolio Manager with continued control over ultimate  decision making, but if the pie truck were to run me over tomorrow, Ryan would be my choice to manage the portfolio. 

We are extremely fortunate in having an investment team where each member would be a star at any other firm, and could  if they wished, leave to launch their own firms. Most members of our investment team that have left Pershing Square in  previous years have been successful in setting up their own firms, and the same would be true for our current team members.  

In selecting among our investment team for a CIO, I chose Ryan for a number of reasons. First, he is of exemplary character  and is an extremely high-quality human being. He is a once-in-a-generation talent as an investor, not just in equities, but also  in macro instruments. He is an excellent leader, teacher, communicator, and partner, and has the respect of each member  of the investment team. As the longest-tenured member of the team, he has had the greatest opportunity to experience our  profoundest successes and failures in dramatically different market environments and to learn from them. He has also had  the opportunity to train most of our team members in our approach to investing.  

We have built a culture that requires extreme candor. Ryan is unafraid to challenge anyone including yours truly, and that  is an extremely important quality in a CIO. Ryan is the right choice, and importantly, when I checked with each of the other  team members, they all agreed. 

My decision to announce Ryan as CIO should in no way suggest to you that I am heading for the hills. I love this business  and intend to stay active until they carry me out, and I am a heavy lift. I don’t expect that our investment team will function  differently beginning the day after this announcement. Ryan has already for some time been unofficially serving in this role. 

It has been an extraordinary year filled with uncertainty, the tragic war in Ukraine, enormous capital markets volatility,  and political divisiveness. Even more so in this environment, we feel extremely fortunate to have the backing of long-term  investors who enable us to do our best work. We are perpetually extremely grateful. 

As always, please reach out to ir@persq.com if you have any questions for us. 

Sincerely, 

William A. Ackman