One of the most prominent investors today is Bill Ackman, the hedge fund manager behind Pershing Square Capital Management, a fund with a history of shorting stocks and active involvement in company management. For a number of years, Bill Ackman was considered a hedge fund “rock star.” As Investopedia details, Pershing Square made very public, successful bets on companies like Municipal Bond Insurance Association. The fund also helped turn around General Growth Properties, resulting in a $1.6 billion profit on a $60 million investment. As a result, Pershing Square increased 40% in 2014, compared to 9.6 percent for the S&P 500.
However, this success was short-lived. Pershing Square took a $1 billion short position in Herbalife, a nutrition company that it believed to be a pyramid scheme. It also took a 9 percent stake in a Valeant Pharmaceuticals. Both investments performed poorly, and Pershing Square was down 21 percent in 2015 and 14 percent in 2016. As a result, Ackman and Pershing Square went from being the darlings of Wall Street to the subjects of scrutiny. Segments on CNBC questioned whether Ackman had lost his touch, and investors were reportedly pulling their money out of Pershing Square, with the fund’s assets under management decreasing from about $20 billion to around $8 billion.
The remarkable change in opinion regarding Ackman and the firm exemplifies the flaws in a myopic investment strategy that gives much greater weight to the last few years of Pershing Square’s performance. When decision making becomes focused on the short-term, long-term results falter. When investors are deciding whether to invest in funds like Pershing Square, they should strongly consider the fund’s long-term track record, rather than its short-term fluctuations.
Another investor, David Einhorn, offers some insight into how to judge investment managers. Einhorn, a value investor like Bill Ackman with a similar level of Wall Street credibility to that of Einhorn, runs a successful fund called Greenlight Capital. Over the past few years, Greenlight has lost money due to some of its shorts, particularly in its short positions in Tesla and Amazon. These stocks soared as Einhorn bet against them and Greenlight suffered tremendously. Greenlight, like Pershing Square, has had a few years of turbulence but a great long-term record. However, this serves as another demonstration of why it’s important for evaluators of investment managers to consider investment theses along with actual performance.
Einhorn’s arguments against Amazon and Tesla are built on the idea that these companies’ stock prices are fueled by growth expectations, marketing, and celebrity CEO’s, rather than by fundamentals. This is a good argument, but it can also be contested. Regardless of whether Greenlight’s performance over the short-term is up to standard, evaluators of investment managers should look into the theses behind the larger positions held by various managers. If their theses seem poorly supported, careless, or based more on trends than contrarianism, they should look to other investment managers, regardless of that firm’s record.
The most important consideration when evaluating an investment manager’s merit is culture. Culture is a concept that’s often overused with respect to business, but it is arguably more important for investment funds than almost any other corporation. Investment funds are businesses that aim to deliver great returns, relative to risk, for investors. This is their primary goal and also their product. However, unlike many other businesses, investment funds do not have intellectual property, patents, brand names, and past products on which their business can rely for profits and performance. For these types of businesses to differentiate themselves from competitors, and perform better, having a successful company culture is critical.
An excellent example of superior workplace culture in investment management is seen in the firm Ruane, Cunniff & Goldfarb. The fund has a successful and illustrious history, as seen by its ability to deliver market-beating returns to its investors since its establishment in 1969. However, like all companies, Ruane, Cunniff & Goldfarb has experienced some difficulty. In 2016, the company lost a significant amount of money on an investment it made in Valeant Pharmaceutical, a company that Bill Ackman also invested in. Ruane, Cunniff & Goldfarb was particularly hurt by this investment because, at one point, Valeant Pharmaceutical made up more than one-third of Sequoia Fund, Ruane, Cunniff & Goldfarb’s flagship fund.
The losses due to the Valeant position were large, but it was an opportunity for the company to test its culture. Ruane, Cunniff & Goldfarb’s response to this moment of difficulty was exceptional. Instead of attributing the performance to misfortune or a single bad thesis, the company changed the way it made final investing decisions, going from a more centralized decision-making process to a five-person investment committee that requires almost unanimous support for an investment to be added into the portfolio. At the same time, the firm refrained from over compensating, maintaining its belief in both its investment philosophy and its other holdings. Since then, the firm has done well and recovered. And, the self-reflection that occurred after the Valeant loss has helped the fund become better organized for the future.
The example of Ruane, Cunniff & Goldfarb shows that it’s important to judge an investment fund based on how it’s organized as a business. Evaluators of investment managers should consider the firm’s culture, in term of whether it can handle periods of misfortune with humility, and whether it can reflect on its mistakes in a constructive way.
Evaluating investment managers will always be difficult, but the process of doing so can improve. If people placed greater focus on a firm’s long-term track record, on the various theses behind a firm’s investments and on the firm’s culture, the process of evaluating investment managers would be greatly improved.