• Charles Heighton

Bill Ackman bets on more lockdowns

By Charles Heighton – The London Financial Markets Editor and VP of Trading at King’s Global Markets

As of this week, Bill Ackman and his hedge fund Pershing Square have re-entered a trade that bets against corporate credit. This same position on a larger scale generated $2.6 billion in profit for Ackman in the first half of the year. This position is different from the last though: it is less of a bet and more of a cautious hedge, hence the smaller size (around 30% of the original position).

This trade involves buying credit default swaps, a form of insurance that pays out if the underlying asset defaults. In this case, the asset is $71 billion worth of corporate debt. When Ackman ended this trade earlier in the year, he had paid only $27 million in premiums, generating a near 10,000% return.

During an FT conference on Tuesday, Ackman stated that he hoped this position lost money because he is betting that governments may have to reimpose strict measures as coronavirus cases continue to spiral out of control. This is ironic, as last time he took this position he went on CNBC and said, ‘hell is coming’ and encouraged lockdowns, which he profited from. This contrast in ways sums up what a year 2020 has been for the markets.

Interestingly, Ackman also made his bullish position on equities clear. At first glance, it is counter-intuitive to bet against corporate debt using insurance while also betting on stocks rising. However, this comes down to the companies that will continue to outperform even in a lockdown environment such as tech, and those that will struggle, for instance, pretty much the rest but especially airlines and hospitality stocks.

During the same conference, Ackman also suggested that the vaccine news from Monday is bearish in the short-term because it will cause people to take fewer precautions, which will result in cases rising. This is a logical take, but it is unclear whether the market will react logically. If cases continue to increase until a vaccine is distributed, the market may shrug off these numbers as it has done recently. When it comes to equities, you can take nothing for granted in 2020.

Pershing Square was massively right on this bet back in February and it resulted in a huge asymmetrical pay-out, as the outlay was relatively small. It was arguably the best performing hedge fund trade by percentage return in history. The fact that Pershing Square has returned to this position even on a smaller scale is a concerning sign. Obviously, hedge funds managers are often wrong but the fund's record this year is impressive, as it is up 44%.

The most troublesome aspect of this news is that the markets have not learned. The terms that Ackman got in February are identical to the current terms, showing that the market has completely disregarded months of economic volatility and spiralling case numbers worldwide. Presumably, because investors have been fixated on the US election result and the vaccine progress. That is not a good sign: it shows a concerning level of complacency. It is shocking that the banks and their customers that facilitated this trade eight months ago are still willing to go after the previous pay-out.

This time, other firms could follow Ackman into this trade due to its previous performance. Retail investors can also join this particular party. CDS ETF’s unsurprisingly do exist, because if it is a financial product, someone will eventually 'ETF-it'. As a note of caution though, these products are complex and should be used with caution. If retail investors want to hedge their equity exposure as Ackman has done, then this might be a good approach. Before doing this though, you need to delve into how the ETF works. It is harder for an individual investor to buy this protection that is for a multi-billion-dollar hedge fund. You must be cautious and ensure that the ETF is selling what you actually want to buy. If you do this research though, the protection it brings could be worth the investment. However, unlike Ackman, you have to speculate on the movement of the ETF rather than paying insurance premiums, leaving you more exposed.

I, along with Ackman, hope that this particular trade loses money, because if it doesn’t, the damage to the economy could be severe. But if Ackman is right, he could go down in the annals of Hedge fund history as the best of an elite group.

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