The One Place to Buy Value Stocks for a 30% Discount

Where else in the stock market can you buy a basket of large-cap stocks like Berkshire Hathaway, Chipotle, and Lowe’s for a 30% discount? What if I went on to tell you that one of the most successful hedge fund managers of the last two decades managed it?

The fund is Pershing Square Holdings (OTC: PSHZF), the closed-end fund managed by Bill Ackman. Buying shares of the CEF is similar to an ETF, but CEFs typically issue debt and preferred shares and are generally actively managed. Most CEFs trade at a discount-to-NAV of about 4%, with very few CEFs reaching the massive discount offered by Pershing.

Why Is Pershing Square Holdings Discounted?

So why is this fund so heavily discounted, even though it’s comprised of highly liquid, mostly blue-chip stocks? The reasoning is two-fold. The first is that the fund’s recent performance has severely lacked that of the S&P 500.

Here’s a chart that compares PSH to the S&P 500. The blue line is PSH, while the orange line is SPX.

The second reason for the fund’s discount is that Bill Ackman saw his investing reputation diminish after two catastrophic investments. Ackman built a massive position in pharmaceuticals company Valeant, which saw it’s value drop about 90%, peak-to-trough. Following his Valeant disaster, Ackman levied a short-seller activist campaign against nutritional products MLM Herbalife. After a Netflix documentary, a public showdown with Carl Icahn (who was long HLF), and a billion dollars in investor capital lost, Ackman’s reputation took a significant blow. Most of Wall Street assumes Ackman has lost his touch.

However, there’s a bright side here. The fund rallied up about 25% since January 2019, handily outperforming the S&P 500, indicating a potential turnaround for Ackman. The market is still highly bearish on Ackman’s future, however.

Here’s a chart comparing PSH’s performance compared to the S&P 500 since January 2019. The blue line is PSH, while the orange line is SPX.

It might be unfair to count Ackman out just yet. Between 2004 and 2019, Pershing Square posted a cumulative excess return over the S&P 500 of roughly 280%.

The Fund

Here are some statistics on the fund:

Discount to Net Asset Value (NAV)	-30.99%
NAV/Share	$25.04
Market Price/Share	$17.76
Dividend Yield	2.25%
Management Fee	1.5%
Performance/Incentive Fee	16%

The fund’s top holdings in Q4 2019, according to the fund’s most recent 13F filing.

• Chipotle Mexican Grill (CMG)
• Hilton Worldwide Holdings (HLT)
• Lowe’s Companies (LOW)
• Restaurant Brands International (QSR)
• Berkshire Hathaway (BRK.B)
• The Howard Hughes Corp (HHC)
• Agilent Technologies (A)

Note that Starbucks (SBUX) was listed as a holding in the Q4 2019 13F, but Ackman told the press that he sold both ADP and Starbucks in February 2020.

Ackman has historically seen himself as an activist value investor, but some of these holdings are indicating that Ackman has begun to incorporate some growth-at-a-reasonable-price principles with his Chipotle stake.

Ackman and Pershing bought about 10% of Chipotle at an average price of $405 in 2016, seeing the company as a turnaround play. Since then, the fund has slowly reduced its stake in the burrito-giant, still holding a massive 1.7 million shares, as outlined in its Q4 2019 13F.

The rest of Pershing Square’s holdings, save for Agilent, are value plays that are generally out-of-favor with the market.

Ackman is an activist investor, meaning he takes a stake in a company, then uses his influence to make operational changes within the company. Ackman describes this as approaching the public markets with a private equity state-of-mind. Ackman had this to say regarding the strategy:

"Unlike private equity, however, we do not pay a premium for control in investment banking-led auctions that are designed to maximize value for the seller, nor do we materially leverage the balance sheet of a portfolio company to enhance our returns."

Here's a chart showing the P/E ratio of the fund's seven primary holdings: 

Catalysts That Can Close the NAV Gap

The fund can opt to wind won or switch to an open-end structure (allowing redemptions at or near NAV). Outside of a change in the capitalization of the fund, if Ackman’s stock picks continue to impress the market, and the current bull market holds, investors will begin to see the value within.

The fund has been aggressively buying back shares since May 2017, hoping to boost sentiment to help close the NAV-discount.

Final Thoughts

Most of the time, when there's a blatant arbitrage opportunity presented in the market, traders quickly take advantage of it, closing the gap. However, due to the unique situation of PSH, this has yet to occur.

To start, the fund charges above-average fees for the CEF industry. The fee structure more resembles that of a hedge fund: rather than “2 and 20,” PSH charges “1.5 and 16” (referring to the management and performance fees, respectively).

As a foreign OTC issue, the fund is unavailable to many investors, and the fund is prevented from marketing to US investors due to the structure. Because of this, the liquidity within the stock isn’t that deep, trading less than 10,000 shares per day. This makes it difficult for large proprietary traders to make arbitrage trades within the stock.

With all of that said, of course, there's a significant risk when there's a basket of stocks available at a 30% discount to NAV.