Ackman Off Target
The dangers of extreme leverage.
But now comes the revelation that his unique hedge fund designed solely to invest in Target (TGT) (a store I really like, by the way) lost 40% in January even though the stock was down less than 10%. The 2-year-old fund is now down nearly 90% since its inception - even though Target is only down about 50% from its all-time high. How did he pull this off?
Leverage, friends; leverage.
I don't know all the details, but I know enough of them. The fund's investment was largely represented by one or more fairly short-dated call options on Target. Such a trade, as most Minyans know, is the financial equivalent of a baseball player who hits with great power but for a very low average. Lots of strikeouts, plenty of home runs, and very few singles and walks.
I imagine Mr. Ackman structured the fund this way both to avoid certain reporting requirements (in other words, to control enough stock to become an insider without actually becoming one) and to make a bigger score if he was really right.
But the irony is that someone so good at identifying the weaknesses in other capital structures could have built one of his own funds on such shaky ground.
The problem, as I see it, with using high leverage as an activist investor is that you're trying to be both a price-taker and a price-maker. And it's very hard to do both. Buying options makes sense when you are sufficiently small relative to the underlying trade. It's very hard, though not impossible, when you are trying to make the move happen yourself.
Apparently Mr. Ackman has restructured what's left of the fund so that it now holds primarily longer-dated options. These have a much greater resemblance to the stock itself than do the more speculative short-term ones.
I like the way Mr. Ackman thinks, and I wish him well. I'm just a bit surprised that someone so cognizant of the dangers of extreme leverage would have subjected his investors and his reputation to their perils quite so much.
The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.
Copyright 2011 Minyanville Media, Inc. All Rights Reserved.
Daily Recap Newsletter