Hedge Funds or the Government?
HerbaLife Put Strategy
I think hedge funds are more help to the investing world and individual investors than are overly restrictive policies and multitudes of regulators. A market that is free of unreasonable government intervention can provide more prevention from risky investments through price discovery and use of independent analysis and ideas. Disallowing short selling for example, is a huge mistake. A Recent disclosure by Bill Ackman provides an interesting a case study.
With Herbalife (NYSE:HLF) very "hot" in the news right now based on the analysis of Pershing Square's Bill Ackman I thought I would review the role of government versus that of hedge funds now and back in 2008. Bill Ackman is an excellent analyst and hedge fund manager. Even though he made more than $1 billion by betting against bond insurer MBIA (MBI), Ackman actually prefers to put his money on businesses that can improve, vs. those poised to crash. Most of Mr. Ackman's investments are traditional long equity ideas. He's well known as activist investor most recently with investments in Target (NYSE:TGT) and J.C. Penney (NYSE:JCP) and a few years back here in the Northeast scooping up bonds and shares of General Properties owner of Providence Place Mall. Ackman's independent research and concentrated investment approach has proved to provide tremendous outcomes. Pershing Square's $60 million dollar investment in (NYSE:GGP) in 2007/8 is worth well over a billion dollars today.
Sometimes great investors will focus on companies that defy gravity or logic with regard to market value and that causes them to do exhaustive research. When the government restricted short selling and made it illegal they apparently hoped to prevent manipulation and /or panic. This strong-armed manipulative effort by the government essentially failed and always will. Short selling is currently banned on banks in countries all over Europe and is completely illegal in some countries. Short selling has largely been a strategy employed by Hedge Funds and proprietary trading desks. The US Government seeks to separate banks from proprietary trading entities, so it is becoming very important to pay attention to the activities of hedge funds. Not every hedge fund touts its short investment themes but Bill Ackman is a different sort and I applaud his free market solution of identifying "long side" equity stock price manipulation and poorly informed misguided analysis. Ackman has actually contributed in both the recent past and in the last decade with (MBIA) the profits on his shorts to charity. What can be more free market than that? First expose inefficiencies to the public for free, thus saving future investors from losses but also contributing profits to charity to emphasize distaste for overpriced investor schemes.
Herbalife is the current target and it isn't your typical short-seller's fight. Start with the fact that Ackman presented his case (PDF) against Herbalife at a special complimentary event hosted by the Sohn Conference Foundation. This annual conference brings together wealthy investors to share their top investment ideas. Mr Ackman guaranteed $25 million to the group that supports pediatric cancer research using the profits he expects on this short.
As unusual as this sounds, it is not the first time this has happened. In 2008 Bill Ackman repeated his attack on Bond insurers Ambac and MBIA contributing short sale profits to charity as well. Ackman's battle with MBIA was turned into a book called Confidence Game (Wiley, 2010). He argued that the billions of dollars of CDS protection MBIA had sold against various mortgage backed CDOs was going to be a problem. He also argued that it was not proper for MBIA, which was legally restricted from trading in CDS, to instead do it through a second corporation, LaCrosse Financial Products, which MBIA described as an "orphaned transformer". Ackman bought credit default swaps against MBIA corporate debt as a way to bet that it would crash. When MBIA did, in fact, crash as the financial crisis of 2008 came to a head, he sold the swaps for a large profit. Ackman reportedly attempted to warn regulators, rating agencies and investors about the bond insurers' high risk business models.
This is proof yet again that it doesn't matter how many regulators you have or hire. The evidence here was turned over to the government just like Madoff was. The way to sort this out,is to let the buyer beware and do their own research and have regulators that respond to info that is proffered. We don't need more regulators we need more free market vigilance.
Here's an Option Strategy that I like, if you lean toward Ackman's thesis on Herbalife. It will be impossible to borrow shares of HLF to sell short for at least a year. So try this, buy 1 January 2012 PUT struck at $30 per share and sell 2 Jan 2014 $15 (strike price) for a net debit of $5. Your profit zone in January 2014 will be between $25 and $5. And the maximum return will be at HLF $15 with a return of 200% on your money. If Shares end up above $30 or at zero you will lose your entire $5 dollar investment. You will have positive return between 5 and 25 at expiration in January 2014.Disclosure:
I am short HLF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: This position is not meaningful to our investment process and is not a recommendation of coastal management group LLC . This is an idea and includes opinions from Michael G Riley.