So, Bill Ackman Makes Some Good Points on the Index Bubble…

10159650595_aea8898457_oHe’s often controversial… and usually pretty brash. But Pershing Square’s Bill Ackman is also usually quite insightful. He’s been at this game a long time, and he’s had his share of big wins… and big losses. Ackman has an ego on him. (What hedge fund manager doesn’t?) But he’s also his own biggest critics, and like all good investors he learns from his mistakes.

Today, let’s take a look at Ackman’s latest letter to investors, which came out last week. Ackman, like a lot of hedgies, had a terrible 2015. Here were some of his takeaways:

Not All Valuation Metrics are Equal

Ackman bet big on Valeant Pharmaceuticals (VRX)… and lost big when the stock rolled over. Per Ackman,

Principally, we missed the opportunity to trim or sell outright certain positions that approached our estimate of intrinsic value. Our biggest valuation error was assigning too much value to the so-called “platform value” in certain of our holdings. We believe that “platform value” is real, but, as we have been painfully reminded, it is a much more ephemeral form of value than pharmaceutical products, operating businesses, real estate, or other assets as it depends on access to low-cost capital, uniquely talented members of management, and the pricing environment for transactions. [Emphasis Sizemore]

Charles here. I learned a similar lesson in 2015. Just as Ackman lost money in an acquisition-hungry pharma stock, I lost money in MLPs, small-cap REITs and business development companies — three sectors that would normally have very little in common. But the tie that bound them was their dependence on the capital markets for fresh funding. When the credit markets got skittish, Mr. Market relentlessly punished these sectors, and two of my holdings — Kinder Morgan (KMI) and Teekay (TK) were forced to slash their dividends.

Know Who You’re In Bed With

Due to Ackman’s high profile, he tends to attract copycats. I myself have been guilty of perusing his SEC disclosures. This creates risks of its own:

Perhaps the largest correlation in our portfolio is one that we have not previously considered; that is, the fact that we own large stakes in each of these companies. We have had the benefit of a “following” of investors who track and own many of our holdings. This has given us significantly greater clout than is reflected by our percentage ownership of these companies, and we believe that it is partially what has caused the “pop” in market price when we announce a new active investment. As a result, these active managers’ performance is often closely tied with ours. When Valeant’s stock price collapsed, our performance, and that of Pershing Square followers, were dramatically affected. Nearly all of these investment managers are subject to daily, monthly, and quarterly redemptions, and therefore, many were likely forced to liquidate substantial portions of their holdings which overlap with our own…

While it is impossible to know for sure, we believe that our continued negative outperformance in the first few weeks of the year relates primarily to forced selling of our holdings by investors whose stakes overlap with our own.

This raises a bigger issue of simply considering who the major holders of your stocks are and what their constraints or motivations might be. Returning to my own losses last year, The selloff in MLP shares was massively exacerbated by mutual funds, ETFs and — most importantly — leveraged closed-end funds and hedge funds that were forced to liquidate to meet redemptions or margin calls. This were holders that were forced to sell at whatever price the market gave them.

The Index Fund Bubble… And What It Means

Finally, Bill Ackman has some insightful comments about the “bubble” in indexing. Given the lousy performance of active managers over the past decade, it’s easy to see why investors continue to flock to index funds. They are cheaper in terms of fees, more tax efficient and have had better returns of late.

But here’s the problem. Indexing only works when their are a sufficient number of active managers to make the market at least semi-efficient. If everyone becomes a passive indexer, then the returns of the major indexes will start to lag in a major way as the stocks in the index become overowned and overpriced.

But there are other considerations too. Passive ownership essentially gives management a free pass and allows lousy management teams to stay entrenched.

As Ackman writes,

As index fund ownership grows as a percentage of shares outstanding, the voting power of index fund managers increases. While on the one hand, one might believe this is good for America as these “permanent” owners should think very long term compared with the many investors whose average holding period is less than one year.

On the other hand, there are significant drawbacks… While index fund managers are, of course, fiduciaries for their investors, the job of overseeing the governance of the tens of thousands of companies for which they are major shareholders is an incredibly burdensome and almost impossible job. Imagine having to read 20,000 proxy statements which arrive in February and March and having to vote them by May when you have not likely read the annual report, spent little time, if any, with the management or board members, and haven’t been schooled in the industries which comprise the index…

Of course, this is impossible. Index managers are passive and will generally toe the line for management. Ackman points out some very significant long-term effects of this, asking the proverbial question of what happens when index funds effectively control corporate America:

If the index fund trend continues, and it looks likely to do so, what happens when index funds control Corporate America? Courts have often deemed shareholders to be in control of a corporation with as little as 20% of the ownership of a company. At current rates of asset inflows, it will not be long before index funds effectively control Corporate America and the corporations of many foreign countries.

The Japanese system of cross corporate ownership, the keiretsu, has been blamed for decades of Japanese corporate underperformance and economic malaise. Large passive ownership of Corporate America by index funds risks a similar outcome without the counterbalancing force of large active investors…

The thought of corporate America turning Japanese should be enough to make even the biggest proponent of indexing pause for a moment.

Ackman says that the “greatest threat to index fund asset accumulation is deteriorating absolute returns and underperformance versus actively managed funds” because money flows into these funds with no consideration of value. I agree, and would add that this was the major rationale for the “smart beta” movement.

But perhaps the greatest takeaway here is simply to not give up on active management. When you invest outside of the mainstream, you will have returns that are outside of the mainstream. That means that there will be plenty of years when you underperform.

But if you’re a good investor, it also means that there will be years where you massive outperform. So keep your chin up. Even hedge fund masters of the universe lose money some years.

Charles Sizemore is the principal of Sizemore Capital, a wealth management firm in Dallas, Texas. As of this writing, he was long KMI and TK.

Photo credit: InsiderMonkey


JC Penney On Express Train to Oblivion

I was on CNBC this week to discuss battered retailer JC Penney (JCP), commenting that the company “is on an express train to oblivion.”

Activist investor Bill Ackman is widely blamed for running the company into the ground, and the criticism is justified.  Ackman installed former Apple (AAPL) retail guru Ron Johnson as CEO, and in a span of less than two years, he managed to alienate (some might say actually antagonize) Penney’s core customer base and shrink the store’s annual revenues by a quarter.

But as destructive as Ackman was during his tenure as a major shareholder, he didn’t create Penney’s problems.  Penney had been losing market share to nimbler retailers like Target (TGT), Wal-Mart (WMT) and Kohl’s (KSS) for years.  In a strong retail market, a marginal player like Penney can survive and have some degree of success.  But the retail market has been soft for years, particularly at Penney’s working and middle-class price points.  Target, Wal-Mart and Kohl’s have all had disappointing years, and Wal-Mart has repeatedly mentioned the difficult financial conditions of its core working-class customers.  If Wal-Mart is having a hard time growing, then what possible chance does Penney have of turning it around?

And this says nothing of the retail elephant in the room, internet retailer (AMZN) and its online peers.  JC Penney has made decent progress online, as have most major retailers.  But Amazon’s insistence on growth over profitability has a way of crimping the margins of virtually all its competitors.

JC Penney was slowly dying before Ackman got his claws into it.  But at this stage in the game, the company will burn through its cash in less than a year unless sales show meaningful improvement.  This brings up a good question: If Penney is dying, might it have value as an asset liquidation play?

Two years ago, I asked tongue in cheek if Sears was the next Berkshire Hathaway, noting that Eddie Lampert, the company chairman, was essentially doing what Warren Buffett did a generation ago: Turning a dying dinosaur into an investment holding company.  Two year later, it seems that Lampert is carrying on as before, slowly selling off Sears’ valuable real estate while keeping the retail operations afloat, but just barely.

So, might JC Penney be a candidate for a similar strategy?

Well, yes, in theory.  Except that Penney put its real estate up as collateral to Goldman Sachs (GS) in exchange for a lifeline loan earlier this year.

Don’t even think about buying Penney stock, even at current prices.  In fact, you should use any end-of-year rally as an opportunity to short.

Charles Lewis Sizemore, CFA, is the chief investment officer of the investment firm Sizemore Capital Management. As of this writing, he was long DVA, MO and MSFT. Click here to receive his FREE 8-part investing series that will not only show you which sectors will soar, but also which stocks will deliver the highest returns. This series starts Nov. 5 and includes a FREE copy of his 2014 Macro Trend Profit Report.

The JC Penney Saga: Are Poison Pills Good or Bad for Investors?

For a staid old department store with a 111-year-old history, JC Penney Company (JCP) has been in the news a lot this year, though not for any noteworthy operational developments; the retailer continues its slow march into irrelevance, and it’s not likely to change course any time soon.

The headlines have mostly surrounded one particularly vocal shareholder, Bill Ackman of Pershing Square Capital, who owns about 18% of the company.  Up until recently, Ackman was also on the JC Penney board of directors…until he resigned in a hissy fit after demanding that the company replace its CEO within 45 days.  And this after Ackman’s choice for the job—former Apple (AAPL) executive Ron Johnson—ran the company into the ground.

Ackman likes to think of himself as a “shareholder activist” who shakes up complacent or self-serving company boards and unlocks value for shareholders.  But to his detractors, he is nothing more than a corporate raider—a pirate in a suit that loots and leaves.  JC Penney Chairman Thomas Engibous called him “disruptive and counterproductive.”   And given Ackman’s recent behavior, it’s hard to argue with the chairman.

All of this brings me to Penney’s new “poison pill” provisions.  After the Ackman experience, JC Penney never again wants to become the personal plaything of a hedge fund titan.  For those unfamiliar with the term, a poison pill floods the market with new stock in the event of a hostile takeover.  It makes it impossible—or at least very expensive—for a corporate raider to take over a company without management’s blessing.  The Penney poison pill would kick in whenever an outside shareholder acquired 10% or more of the company’s stock.

And this is where the theater of the absurd starts.  The poison pill is being called a “shareholder rights” plan by management.  So, we have a “shareholder rights” plan being implemented to protect investors from “shareholder activists” like Ackman.  If you’re a Penney shareholder, you must really feel special.  It looks like everyone is looking out for your best interests.

Except that they’re not.  Corporate raiders like Ackman—and some of his high-profile rivals like Carl Icahn and Daniel Loeb—are absolutely correct when they say that corporate managements tend to run companies for their own benefit rather than for the benefit of the shareholders.  In business school they call it the “principal-agent problem,” but we don’t need to get bogged down in fancy terminology.  Unless motivated by altruism or idealism, people tend to look out for number one first.

So if management are the “bad guys,” does that make Ackman & Co. the “good guys.”

If you believe that then you have no business investing.  “Shareholder activists” may inadvertently help smaller shareholders by driving up the stock price after successfully engineering a reorganization of the company.  But they do so for their own benefit, not yours.  This is Wall Street…not charity.

So, now that I have sufficiently jaded your view of humanity, what are we to do with this information?  Should we view poison pills favorably…or should we run away screaming when a company we own implements one?

I would frame it like this: If you’re investing in well-run companies, it generally won’t matter.  Good companies with healthy prospects generally don’t need poison pill provisions.  Yes, Bill Ackman made a mess of JC Penney.  But JC Penney was already a company in terminal decline long before Ackman got his paws on it.  Rather than waste your time and capital on an investment in Penney, you could have invested in a healthier rival like Wal-Mart (WMT) or Target (TGT)—both of which are monster dividend raisers and share repurchasers.

And Wal-Mart is a fine example of the next point I’d like to make.  If your last name is Walton, then your livelihood disproportionately depends on the performance of Wal-Mart.  The same would be true of Michael Dell and Dell Inc. (DELL).  When your name is on the signage, the company’s destiny is your destiny; you can’t simply walk away.  But outside investors—and particularly regular, individual investors—have the luxury of voting with their feet.  If you don’t like the way a company is run, don’t waste your time in a shareholder proxy fight that you can’t realistically influence.  Sell the shares and allocate your funds elsewhere.

Finally, while you should always assume that a large high-profile investor is investing for their own benefit and not yours, it doesn’t mean you can’t tag along for the ride.  I regularly look at the trading moves made by my favorite money managers.  But be careful here and choose your gurus and their picks wisely.  Yes, Carl Icahn is a smart investor, and yes, tracking his trading moves can be insightful.  But I would steer clear of some of his recent high-profile buys like Dell and Herbalife (HLF). Both have become battlegrounds for hedge fund titans, and as an individual investor you have a serious information disadvantage.

Disclosures: Sizemore Capital is long WMT.

And the Masters of the Universe Say…

In my last article, I noted that “Big Money” managers was wildly bullish on U.S. stocks—74% were bullish and only 7% were bearish.

But what about those legendary masters of the universe—the global macro hedge fund managers who, if their reputations are to be believed, hold the fates of companies and even entire countries in the palms of their hands?

At last week’s Ira Sohn Investment Conference, we got to hear the latest investment themes from some of the biggest names in the business, including Bill Ackman, Jim Chanos, Stanley Druckenmiller, and David Einhorn, among others.

Some of these “smart money” guys haven’t been looking too smart of late.  Ackman has taken enormous losses in JC Penney (NYSE:JCP); at one point, his losses on the investment were over $500 million.  He also appears to be on the wrong side of a very large short position in Herbalife (NYSE:HLF).

This year Ackman is recommending Procter & Gamble (NYSE:PG), even though it is sitting near 52-week highs and is trading at a substantial premium to the broader market…after a long run in which consumer staples have outperformed.  Ackman is agitating for management change.  We’ll see how Ackman’s recommendation plays out, but I wouldn’t expect market-beating returns here.

Most of the speakers focused their comments on individual stocks, but there were some “big picture” themes worth noting as well.  Kyle Bass of Hayman Capital reiterated his bearish call on Japan, saying that “the beginning of the end has begun.”  I agree with Bass’ view on Japan and recently called it “the short opportunity of a lifetime” here on the Trading Deck.  I can’t say I agree with Bass in his bullish defense of gold, however.

Stanley Druckenmiller, a legendary investor and a former top trader under George Soros, had perhaps the most interesting macro perspective.  Druckenmiller argued that the commodity supercycle—the massive decade-long bull market enjoyed by most commodities—is over.  The primary culprit?  A slowdown in commodity demand from China.

I would take Druckenmiller seriously here.  This is a man who enjoyed a 30-year run without losing money and who is one of the best managers alive today.  Druckenmiller sees the slowdown in China—coming at a time when commodity production is being ramped up globally—resulting in a supply glut and sharply lower prices.  This is good news for companies with large raw materials costs and for countries that import large volumes of commodities, but it is very bad news for Brazil, South Africa and Australia, among other resource-rich countries.

Still, you might want to take the words of all of these masters of the universe with a grain of salt the size of their egos.  88% of hedge fund managers underperformed the S&P 500 last year.

Disclosures: Sizemore Capital has no positions in any security mentioned.   This article first appeared on MarketWatch.

Charles Lewis Sizemore, CFA, is chief investment officer of the investment firm Sizemore Capital Management and the author of the Sizemore Insights blog.

Five Smart Money Dividend Stocks

Now and then it is nice to take a peek over the shoulder of a successful investor to see what their high-conviction buys are.  When you read a headline that “Warren Buffett is buying Company X,” you’re naturally inclined to do a little digging into Company X’s financials.  After all, if it’s good enough for Buffett, it might be good enough for you.

You have to be careful with this line of thinking, of course.   The SEC filings that disclose the holdings of large investors are generally pretty dated by the time we have access to them.  For all we know, the conditions that made a guru buy a given stock may no longer be valid by the time we read about it, and there are no guarantees that they haven’t already sold it.  For these reasons, I tend to focus on larger holdings, the conviction buys that they are likely to hold onto for a while.

Today, I’m going to look at one high-conviction dividend stocks each from five well-known superinvestors.  My criteria is simple enough: the stock must be a significant holding in the guru’s portfolio and it must pay a respectable dividend.





Warren Buffett Wal-Mart



David Einhorn Apple



Joel Greenblatt Northrop Grumman



Bill Ackman General Growth Properties


Mohnish Pabrai Goldman Sachs




We’ll start with Mr. Buffett.  Warren Buffett’s Berkshire Hathaway ($BRK-A) has been accumulating shares of retail behemoth Wal-Mart ($WMT), and it’s not hard to understand why.  Wal-Mart is exactly the kind of company that Buffett is famous for buying.     It has a dominant position as the leading discount retailer in the world.  It has competitive “moats” in its size and logistical efficiency that competitors have a hard time scaling.  And naturally, it’s attractively priced. Wal-Mart trades for 14 times 2013 expected earnings and at 0.55 times sales.  Its 2.10% dividend, while not exceptionally high, is growing at a nice clip.  Wal-Mart raised its dividend 9% last year and 20% the year before.

Our next guru is David Einhorn.  Einhorn is better known for some of his high-profile short positions—he even wrote a book about his short of business development company Allied Capital, Fooling Some of the People All of the Time—but he is certainly not afraid to make large, concentrated long bets as well.

As of his most recent filings, former high-flyer Apple ($AAPL) was his largest holding by a wide margin at fully 15% of Greenlight Capital’s publicly-traded long portfolio.

It is debatable whether Apple should be considered a “dividend stock” given that the company only recently started paying a dividend and yields less than the broader S&P 500.  Still, given Apple’s gargantuan $100 billion cash hoard and continued shareholder agitation, it is safe to assume the dividend will be rising in the years ahead.

Joel Greenblatt of Gotham Capital is one of my favorite gurus. His “Magic Formula” is one of the best stock screeners I have ever come across, and he gives away access to it for free.  I’ve stumbled across more great investment ideas than I can count from browsing his site, and I recommend that you give it a look.

Greenblatt is heavily invested in defense firms these days, and one that caught my eye was Northrop Grumman Corporation ($NOC).

Northrop Grumman is not a “high conviction” pick of Greenblatt, per se, as its weighting is not materially higher than any of his other holdings.  It is, however, a highly-profitable company selling at a very attractive price.  Northrop Grumman trades for just 9 times expected 2013 earnings and yields an impressive 3.3% in dividends.

Next on the list is Bill Ackman, Greenblatt’s former partner at Gotham Capital and the principal of Pershing Square Capital Management.  Ackman is an activist investor with a history of taking large positions in companies and then agitating for radical change.

One such company in need of radical change is the iconic American retailer JC Penney Company ($JCP).  Penney is Ackman’s largest position, comprising fully 17% of his portfolio.

The company recently cut its dividend and is in the midst of an existential crisis, so we’ll move down the list to his first dividend stock of any size, diversified REIT General Growth Properties ($GGP).

A retail REIT may raise eyebrows when consumer spending appears to be slowing, but investors don’t appear to be worried. General Growth is up 20% year to date, roughly double the return of the S&P 500.

With a yield of 2.20%, General Growth is certainly not a big income generator, particularly by REIT standards. Still, a reliable 2.2% is attractive in a low-yield world.

As a side note, Ackman has a large position in Sizemore Investment Letter recommendation Beam Inc ($BEAM), the maker of Jim Beam bourbon whiskey.  Though not much of a dividend stock, it is attractive as a recent spin-off and as a money-minting sin stock.

Finally, we come to Mohnish Pabrai, author of the Dhandho Investor and one of my favorite investors. Pabrai is known for running a highly-concentrated portfolio and for good reason.  As of his most recent filings, two thirds of his portfolio was invested in the financial sector.

Pabrai’s largest holding that pays a dividend of any size is Wall Street superbank Goldman Sachs (GS), which yields a modest 1.8%.

Pabrai is betting big on the financial sector, and Goldman alone accounts for over 19% of his portfolio.  To say that this was a “high-conviction” investment for Mr. Pabrai would be an understatement.

Of all the guru stocks profiled in this article, the one I find most compelling is Mr. Buffett’s Wal-Mart, which I own both personally and in client accounts.  Though considering the track records of each of the gurus, a case could be made for considering any of these dividend-paying stocks.

Disclosures: Sizemore Capital is long BEAM and WMT.