Bill Ackman’s Loss Of Rs. 13,000 Cr In “Next Berkshire Hathaway” Stock Exposes Perils Of Concentrated Portfolio

Bill Ackman, the charismatic whiz-kid Billionaire founder of Pershing Square, a hedge fund, is one of the savviest investors you will ever meet. In an interview, he revealed that his philosophy is to buy very high quality companies which are dominant and super-predicable, with free cash flows, with a moat around them, businesses that are not exposed to commodity prices, etc. He also revealed that he likes to research companies thoroughly and make super-concentrated bets on them. “Why invest funds in the eleventh best idea when the first ten can do the job” he asked.

The fund has assets worth about $20 Billion (Rs. 1,35,000 crore). As of February 2015, there were six major stock holdings in the portfolio of which Allergan took up 34%, Air Products & Chemicals took up 17%, Canadian Pacific Rail took up 14% and a few other stocks make up the balance.

Valeant Pharmaceuticals is Pershing Square’s latest acquisitions. The Fund has invested 20% of its capital in Valeant. Bill Ackman described Valeant as the “next Berkshire Hathaway” owing to its strategy to systematically acquire other companies in order to increase its own value.

Everyone followed Bill Ackman’s lead and piled on to Valeant Pharma, turning it into the “hottest stock on Wall Street”.

Unfortunately, the party came to an end when certain public spirited citizens asked why the Company is engaged in “price gouging” by aggressively raising the prices of life-saving drugs. Hillary Clinton, a presidential candidate, took a cue from the public outrage and promised to end arbitrary pricing for drugs if she was voted into power. That sent the stock price of Valeant and other Pharma stocks tumbling over fears that the Government may impose price regulations.

The nail in the coffin was when Citron Research, run by activist short-seller Andrew Left (who is actively shorting Valeant), alleged accounting malpractices and fraud in Valeant and its affiliate Philidor and called it the “next Enron” (see timeline of Valaent scandal).

Since then, the stock has been on a nosedive. In just the last three months, Valeant has lost nearly 63% of its market capitalisation. The loss in the last month is itself 47%. In the last five days, the stock is down 20%. According to Bloomberg, Valeant’s market capitalization went from $2 billion in 2010 to $90 billion in August, only to crash below $35 billion in less than three months.

Pershing Square is believed to have lost nearly $2 Billion on Valeant. The Fund is down 15.9% YTD. Sequoia Fund, another major shareholder, is reported to have lost $1.2 Billion.

The worst part is that Citron Research, the short-seller who broke the news about the Enron-like fraud in Valeant, sent an ominous tweet on Friday evening promising that it would reveal “dirty news” on Monday which would send Valeant to zero!

$VRX has a better chance of going to 0 than $HLF EVER will. Citron to update full story on Monday. Dirtier than anyone has reported!!

— Citron Research (@CitronResearch) October 30, 2015

When reports last came in, Bill Ackman was desperately trying to defend Valeant and prove that it is not guilty of the alleged misdemeanors.

However, the important take-home point from the episode is that a concentrated portfolio carries enormous risks. Though Pershing Square, Sequoia Fund, the other funds and their army of researchers did all possible due diligence, they still got taken for a ride because of some circumstance or event that they could not foresee. If such super-savvy investors are not able to foresee risks, ordinary investors like you and me have no chance at all. If we get one or two stock picks wrong, our portfolio can be destroyed beyond repair.

This reminds me of the advice offered by Kevin O’Leary, the fund manager. Kevin says (@17.20) that “Diversification is the only free lunch in investing”. He says that the basic principle that he follows is never to invest more than 5% of the portfolio in any one name no matter how great the story is. Also, he ensures that the allocation to any one sector never exceeds 20%.

It is also worth noting that almost all the savvy investors that we track such as Dolly Khanna, Vijay Kedia, Ashish Kacholia etc have diversified their portfolios, stock-wise and also sector-wise.

So, given the debacle that Bill Ackman’s portfolio is seeing right now, it would be sensible to follow Kevin O’Leary’s advice and ensure that our portfolio is properly diversified so as to avoid any unpleasant consequences.