The Greatest Trade Ever

I do right now they'll want to bring in Bill Ackman on the phone he took the Twitter today to urge the president to take more dramatic measures to stop the spread of the virus bill I thank you for joining us today thank you God this interview is from March 18th where CNBC had hedge fund manager Bill Ackman on its shell during this interview Ackman was in the middle of selling a position that had increased a hundred times in value and made his firm a profit of 2.6 billion this video we'll go through that trade which some are calling the greatest trade of all time we'll let you be the judge of that but making a hundred times your money in a thirty day period works out to this percentage yearly return a number so big that we don't even know what this number is but before going into the trade welcome to our channel the market is open please smash the like button if you like this type of video also check out our second channel TM IO Tesla which features Tesla videos so who is Bill Ackman well he's a legendary hedge fund manager that manages about 12 billion dollars in assets 6 billion through a publicly traded stock that anyone can buy and it's listed on the English and Amsterdam markets and he manages about six billion dollars privately you might also have heard of him as the guy who tried to unsuccessfully short Herbalife a nutrition supplement company this failed bet from about 2013 to 2018 ended up costing his firm about a billion dollars this led to Ackman having terrible performance from 2015 to 2018 in fact his returns were negative each year and many investors actually began withdrawing from his fonda Ackman was being counted out and he was motivated to turn around this performance in 2019 his fund returned a staggering 58% and he became once again one of Wall Street's favorite fund managers his fund since inception has returned 885 percent compared to only two hundred and fifty nine percent of the S&P 500 this works out to about a fifteen percent yearly return for Ackman compared to only 7.5 percent of the market so Ackman's powers were growing as we approached the crisis in early 2020 so what was Ackman's big short position and how is it different from the famous original big short position Michael burry a famous hedge fund manager was featured in a book called the big short and later a Hollywood movie in 2015 of his famous trade that helped his fund return a hundred and sixty-seven percent in 2007 and he closed his fun earning almost 700 percent before fees brewery like Ackman bought credit default swaps we will soon explain how these swaps work in a more thorough example but for now let's let Warren Buffett the legendary investor explain the basics [Music] they can be a very destructive instrument I mean if you think about it you can't go out and insure my house against fire because you do not have an insurable interest as they call it in the trade because once you insure my house against fire and you may decide that you know that maybe dropping a few of matches might be a good idea however there is a key difference enactment speak short to burries burry started shorting mortgage bonds in 2005 and it took him until 2007 to realize his profits this was a big issue as investors worried when the fund lost eighteen percent of their money in 2006 the position was such a liquidity drain that if barese other assets stayed flat his fun would lose 8% a year because of this client started withdrawing their money and brewery had to cut his position by almost two-thirds as clients withdrew money it seemed that burry would have to liquidate the position at a huge loss to mitigate this risk he took draconian measures and he suspended all client withdrawals even with the suspension of withdrawals if the bet didn't pay off in 2007 and if it took another two years for the mortgage market to implode burry may have lost it all fortunately for him the bet did pay off in 2007 and he was able to liquidate his position at a humongous profit so imagine Bill Ackman now his trade is almost exactly the same as Michael buries except instead of taking about two years to pay off he got his pay off in about 30 days how did he do it let's go through with the big short number two in February 20 21 was increasingly concerned that the market was about to blow up because of the coronavirus he said the following when I did the math I said you know the laws of probability tell me this thing is going to be everywhere every one fifty percent of the world is going to get infected and I sort of rolled this thing forward and I said it's just it's just a matter of time at first he was so nervous that he thought about liquidating just all his assets and going a hundred percent in cash he then calmed down and he thought of a way to protect his portfolio without selling his stocks he then updated investors on March 3rd with an ominous message he said during the past 10 days we have taken steps to protect the portfolio from downward market volatility we have done so because we believe that efforts to contain the coronavirus are likely to have a substantial negative impact on the US and global economies and on the equity and credit markets Bill Ackman like brewery used credit default swaps to make money the reason for using credit default swaps is is actually a safer way to bed for defaults and bonds so even though the movies called the Big Short technically you're just buying insurance and in reality you're actually going long in the position so essentially as Warren Buffett says you're basically buying insurance on a home but you don't own the home so you actually just hope it burns down but if the house doesn't burn down you only risk losing those insurance premiums that you paid typically a usual short position has unlimited losses if the asset keeps going up in value so credit default swaps protect your downside risk so Ackman used credit default swaps as his weapon of choice to bet against the market will later show at the end his risk if the bet did go awry while burry bet against mortgage bonds Ackman turned his eye towards corporate bonds which were trading at historically low yields meaning the market determined that these assets were the safest they've ever been in corporate bond insurance was also at historic lows at only 50 basis points or 0.5 percent he felt given the effects of the virus the price for insurance would rise from 50 basis points to some higher number it eventually did rise to a price of about three times this 50 basis points or 1 point 5 percent but this begs the question how did Ackman then make a hundred times his money if the price for insurance only rose 1 percent or about three times so first if you'd like to calculate how a credit default swap is valued we have a free sheet on our patreon page showing different type of investor inputs but basically for credit default swap insurance to rise from 0.5 percent to 1.5 percent you would need the probability of bond default to go from about 1.5 percent to 5 percent this essentially just means that you would expect now 5% of all bonds to default so this happened but how did Ackman make a hundred times his money well he bought a lot of insurance protection Ackman said in his update letter on March 25th that he paid only 27 million for credit protection what he doesn't necessarily spell out is this 27 million has to be paid monthly for five years so per year that would be 324 million dollars so if the bet didn't pay off in a year he would lose 6% of all his funds money or 324 million dollars on just this one position but if we take that number of 324 million a year divided by the credit default insurance rate of 0.5% that turns into sixty four point seven billion of bonds that Ackman was buying protection on to give a sense of how large that is the u.s. investment grade corporate debt market is just over six trillion so Ackman was essentially buying insurance against 1 percent of all these bonds the second part of our sheet is on the second tab and you can see how this value would go from about 1.6 billion to about 4.3 billion here is why so the first one is imagine you're an investor getting about 27 million dollars a month which is what Ackman was paying 27 million a month for 12 months times five years is about 1.6 billion the reason it is 5 years is a typical credit default swap contract is for 5 years the value of this holding is then discounted by what the US Treasury rate is which was around 1.5 percent so the present value is about one point five five billion however what happens now if the risk rises by three times and now you're paying insurance premiums of about seventy three million dollars a month seventy three million dollars a month times 12 months times five years is about four point three billion or about four point two billion discounted at the risk-free rate if you subtract the difference between the two present values the difference is an increase of about two point six billion dollars in value which is the profit that Ackman made so Ackman quickly had a two point six billion dollar paper gained because he can now sell this position to someone else who wanted to buy credit insurance quickly let's just see what would happen if the price for credit insurance dropped by half as can be seen Ackman's paper value would decline by about eight hundred million but Ackman was fairly confident with credit default swaps at record lows for investment grade bonds that they wouldn't go much lower therefore he didn't expect to lose this amount the money on march 18th when Ackman went on CNBC he had already sold half his position and he was able to completely exit his position by March 23rd right at the peak prices have declined somewhat since then but they are still quite elevated as can be seen credit default swaps are still at about a hundred and twenty basis points for insurance well above the price that Ackman originally bought his position at what was even better for Ackman is that he exited his big short position around March 24th when the market was at its lows or down about 24 percent he then began using this profit to buy his favorite stocks Ackman said he increased his stake in Hilton by 34 percent Howard Hughes by a hundred and fifty eight percent and he even bought more of Buffett's company Berkshire Hathaway this a hundred times profit on a twenty seven million dollar investment has led Ackman to be up sixteen point five percent this year compared to the S&P 500 which is down a bit more than eleven percent on the air and he's part of a trade that may inspire another movie and may go down as one of the greatest trades of all time let us know in the comments what trade you think was better Ackman's was certainly better on paper but burry definitely did a lot more research lachman's bet relied mostly on his keen sense of intuition so was Ackman yelling fire on March 18th Ackman appeared on CNBC and this interview has become quite controversial because during it he said that the US should shut down its entire country for 30 days thank you a number of ideas you put forth I'm gonna read one of them for our viewers to start mr. president the only answer is to shut down the country for the next 30 days and close the borders you say tell all americans that you are putting us on an extended spring break at home with family keeping only essential services open a lot of people say his position would greatly benefit from this shutdown at first blush it appears he bought fire insurance and then yelled fire hoping the insurance premiums would increase in value this is something that Buffett has criticized as we showed in that video however here are the actual facts Hackman had bought his position in late February and as can be seen prices had already increased by then so the market was already yelling fire by this time Ackman then appeared on TV and he started yelling fire too but the market was already yelling it at this time so essentially Ackman bet there would be a fire before everyone else did then everyone could see the fire and fire insurance prices went up and then Ackman went on TV and he started yelling fire in addition Ackman did protect himself a little bit more because he said during the same interview that he was buying a lot of stocks such as Hilton later that day he also sent out two tweets saying that stocks were at a bargain of a lifetime he said that is why we are buying stocks these are at bargains of a lifetime if we manage the crisis correctly so what do you think was this interview by Ackman on CNBC unethical we don't think so but we'd love to hear your thoughts thank you for watching please give the video a like if you enjoyed it

Channel: The Market is Open

Views: 1,200,765

Rating: 4.9116907 out of 5

Keywords: Bill Ackman, Ackman, Pershing Square, Buffett, Warren Buffett, Berkshire Hathaway, Michael Burry, Scion Capital, Burry, Credit Default Swaps, The Big Short, The Big Short #2, Stock Market, Investing, Insurance, Hedge Fund

Id: PejJZIlqRQE

Length: 11min 48sec (708 seconds)

Published: Sat May 16 2020