Bill Ackman's Pershing Square Annual Report

The benefits of Bill Ackman's strategy are relatively clear. But to address the opposite, the downsides, a few of my criticisms are how shortsighted – meaning short-term – and market-obsessed this approach is. I have explained some of these criticisms before, and the charts included in the presentation show how Pershing is essentially pursuing a classic trading strategy, as opposed to a value investing strategy of intense patience and being unconcerned with whether the stock exchange is open or closed. Mr. Ackman and Mr. Market appear to take each other very seriously. And this approach works – just look at George Soros or Steven A. Cohen or whichever successful trading operation. But it probably isn't replicable by individual investors, even if they're attempting to buy the same securities. One example is Borders Group, where Pershing intervened in a potential liquidity crisis and became a creditor, obtained valuable warrants, as well as an agreement to potentially buy Borders' high-quality Paperchase business at an undervalued price. This delivered substantial value to Pershing at the expense of common shareholders. (Why would shareholders benefit from selling Paperchase to Pershing for half price? Would Warren Buffett make this move?) That said, Ackman makes it clear that Borders is exactly as I noted – a very cheap call option – and also makes clear that a mere 1% of his portfolio is at risk. Yet, another distinction between Pershing and common shareholders is that the former began accumulating Borders shares at above $20 each, whereas the latter can now accumulate them for about 50 cents. I strongly believe that shareholders are best served by owner-operators, who make disciplined decisions – often unpopular decisions, when short-term fixes are available – to deliver excess returns over the long term, and to build great businesses.

Paulson Funds Annual Report

Paulson's merger arbitrage commentary is particularly interesting, in the sense that buying Anheuser-Busch stock would have been an incredibly risk-averse investment over anything but the short-term; and the upside was a 90% return when calculated on an annualized basis. This is a strategy that almost anyone could have implemented.

Also, Paulson explains the reasoning and analysis behind his historic bet against subprime and financials, which is extremely valuable reading. Paulson states that we are halfway through the crisis; yet he has liquidated his bets against subprime and is beginning to make select investments in distressed debt and other long positions within the credit and financial space.

Going forward, he makes it very clear that being a long investor in financials will generate immense returns when the markets rebound, throughout either 2009 or 2010.

Paulson Funds Annual Report

Publish at Scribd or explore others: Business Presentations & Slid investing stocks

Some Thoughts on Short-Selling

With the backdrop of this year’s historic short-selling successes, I was recently asked why I rarely engage in this practice.

After thinking about it for a while, my answer is basically this: It is too difficult to be consistently right on timing and other factors. Timing matters much more with selling overvalued assets that you expect to depreciate, as opposed to buying undervalued assets that you expect to appreciate.

Over time, stocks generally increase in value, and holding long-term short positions is costly. Moreover, the possibility of unknown, intervening events gives shorting a different risk profile: for example, a weak company might get bought out, leading to a dramatic increase in the stock price.

Sharp surges in price are much more dangerous for the short-seller than are sharp declines for the stockholder. In the latter case, if one does not use margin, volatility scarcely matters as long as the equity remains attractively valued and the fundamentals have not deteriorated.

By contrast, to look at successful short-sales, consider that Bill Ackman had been short MBIA since 2002. In other words, he thought it would fail during the last recession. He took losses over an entire business cycle for the company to finally break down. David Einhorn waited a similar period of time with Allied Capital, as the stock rose smartly.

You can't get a margin call on equity. Or, in other words, the reverse of shorting is buying equity on margin. Imagine buying a stock at $50 and having it drop to $20 – being forced to sell – and then having the stock sharply rebound. This type of thing happens with shorting all the time, making it dangerous to short technology stocks or commodities or whatever else. Highly overvalued assets can get insanely overvalued, long enough for you to get tapped out.

The other option, no pun intended, is to use puts. The problem here is that equity doesn't expire worthless. But with puts, you can be exactly right with your decision, wrong on timing, and the put option expires worthless. (And then, the next day, the stock plunges to $0.) In my view, anything time-sensitive is absolute rat poison, unless the terms are exceedingly generous.

You want to look at it the way Warren Buffett looks at insurance: unless rates are incredibly appealing, relative to risk, then you simply do not write business. As he says, success at investing is all about temperament. The best action is often to take no action at all.