Bill Ackman's Pershing Square Holdings Ltd. (OTC: PSHZF) suffered significant losses and underperformed the Standard & Poor's 500 Index (S&P 500), the Russell 1000 Index and the Dow Jones Industrial Average (DJIA) in 2015. Pershing Square had a gross return of -19.30% and a net return of -20.50%, while the S&P 500, the Russell 1000 Index and the Dow Jones Industrial Average returned 1.4%, 0.90% and 0.20%, respectively. Pershing Square's significant losses were attributed primarily to its large stake in Valeant Pharmaceuticals International Inc. (NYSE: VRX), which experienced a 90.84% decline from its 52-week high to its closing price on June 14, 2016.
Pershing Square's returns may suffer again in its positions in 2016. The fund has built a large notional short position in the Chinese yuan to protect against the potential weakness in the Chinese market. Moreover, Pershing Square has purchased options on the Saudi riyal to hedge against the potential continued sell-off in the energy market. However, developments in Saudi Arabia may cause large losses in Pershing Square's short position on the riyal. Between Jan. 1, 2016, and April 30, 2016, Pershing Square was down 18.60%, while the S&P 500 and Dow Jones were up 1.70% and 2.80% over the same period, respectively.
Short Positions on Yuan and Riyal
Pershing Square has shied away from credit default swaps (CDS) as a hedge but has used options to build a hedge against potentially unfavorable moves and black swan events. In its January 2016 letter to shareholders, Ackman depicted his hedge and the potential risks associated with China and oil prices. Since the cost of purchasing put options on the Chinese stock market and oil prices were expensive, Ackman built a short position on the yuan and riyal to hedge the fund's portfolio during the summer of 2015. Ackman purchased put options and put spreads on the yuan for inexpensive protection against an unanticipated weakness in the Chinese economy. Additionally, Pershing Square placed a "bet" against the riyal in hopes of the fixed rate dropping. Consequently, Pershing Square purchased put options on the riyal against the decline in energy prices.
China and Saudi Arabia have spent hundreds of billions of dollars in an attempt to protect their currency pegs to the U.S. dollar. Consequently, the fund's currency puts have only generated a modest profit. Additionally, in the letter to its shareholders, Pershing Square stated that these positions have not served as a useful hedge against declines in its investments. The fund said it would continue to hold onto these positions since there is still an attractive risk/reward.
Bad News for Ackman
Ackman's put options on the riyal may start losing value in 2016. The Saudi Arabian central bank has announced that it is banning the use of options and other derivative securities to speculate against the riyal to reduce pressures on its currency peg. However, nonspeculative trades in the riyal forwards market are not forbidden. Banks in Saudi Arabia are banned from accepting any trades in options against the riyal. According to Reuters, "The central bank did not respond to a telephone call to its headquarters seeking comment."
The Saudi Arabian Monetary Agency wants to minimize the snowball effect that the riyal may have in the forwards markets. The move to ban the use of derivative securities is an attempt to prevent crude oil prices from continuing lower, which is one of the primary reasons Pershing Square is invested in put options on the riyal. Saudi Arabian authorities aim to prevent more currency traders from speculating on Saudi Arabia not being able to maintain the riyal's peg to the U.S. dollar. The Saudi Arabian government is expected to announce details of a plan aimed to reduce the reliance on crude oil. Consequently, this is more bad news for Ackman's Pershing Square.
