Bill Ackman’s 100x Credit Default Swap Hedge - 2020 Stock Market Crash

After half a decade of under-performance, things were looking up for Bill Ackman and his hedge fund Pershing Square: his bet on ADP worked out wonders, allowing him to earn his first performance fee in years; and early this year he had exited his position in Starbucks for a return of 73%.

In February, however, Ackman saw the writing on the wall and knew he had to take a pro-active stance in order to protect his investor’s capital, in the face of an impending market crash.

His first instinct was to liquidate Pershing Square’s entire portfolio, but he quickly thought better of it, as such a rash decision would be incongruent with the fund’s long-term ownership philosophy of quality names like Hilton, Chipotle Mexican Grill and Restaurant Brands International – owner of Burger King, Popeyes and Tim Hortons.

Like Dr. Michael Burry from “The Big Short” before him, Ackman expressed his bearish views through credit default swaps.

Credit Default Swaps (or CDS for short) are essentially insurance contracts on the underlying bonds – housing bonds in Dr. Burry’s case, and a basket of CDS issued by North American and European companies, as well as companies in emerging markets.

Bill Ackman’s fund initiated the hedge when these CDS baskets were trading near all-time lows of 50 basis points, i.e., 50 times 1/100 of a percentage point, or 0.5%.

This refers to the annual premium, or the cost to insure against a bond default, and Pershing Square acquired a notional position of $64.8 billion as a way to hedge the portfolio.

This means Ackman entered into a contractual obligation to pay monthly premiums of $27 million over a five-year period.

($64.8 billion * 0.005 = $324,000,000 / 12 = $27,000,000)

He didn’t have to wait long for the bet to pay off, because by the time he started offloading his position in mid-to-late March, the premiums had skyrocketed to around 130 basis points, earning him and his investors a legendary return on investment in what will go down in history as one of the greatest trades of all time.

($27,000,000 * 60 months) = $1.62 billion
-----//-----
(130 basis points / 50 basis points = 2.6x)
($27,000,000 * 2.6 = approx. $70,000,000)
($70,000,000 * 59 months (one month had elapsed) = $4.13 billion)

($4.13 billion - $1.62 billion = $2.51 billion in profit)

References:
- Sheetz, Michael; CNBC Davos 2020 – Ray Dalio says ‘cash is trash’ and advises investors hold
a global, diversified portfolio; 01/21/2020
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About 20% in Quarter; 04/03/2020
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his whole portfolio […]; 04/07/2020
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Takedown Of Herbalife; 12/21/2012
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Gain; 02/05/2020
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10/09/2018
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Choice for Shareholders (48 pages); 11/01/2017
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$1.2 Billion – And Earned His First Performance Fees in Years; 08/06/2019
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fund?; 10/14/2010
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Market Lessons; Timestamp:14:55; 10/16/2017
“Dollar/Yen options...we had options we had bought for $10,000 and they were selling for $17
million.”
- Lewis, Michael; The Big Short; p.185 / 188
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a genius investment. [...]; 05/13/2020
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from MIT and State Street finds; 02/05/2020

[billfraser]

He actually made 3 genius moves. q1. 1. Taking the hedge which paid off 1 month later, 2 Closing out the hedge, and 3 Plowing the profits into existing positions in March catching the V shape bounce back. That made him 2 b too. Step 1 hedged offset the portfolio loss. Step2 & 3 took the cash and expanded his positions in core holdings. 3 perfect timing moves.

[patrickbenson]

Is it weird to have man crushes on hedge fund managers for the sheer amount of balls they have? Asking for a friend of course

[yashpatel]

I was wondering why he didn't use put options or a futures contract to hedge?

[billfraser]

go down in history as one of the greatest trades of all time! I agree and ty for taking the time to explain it. He took a smaller position in CDS at end of june 4.9 b

[andrerothweiler]

As I guy who likes to invest, never short or trade on margin

[DanielNyong]

Keep it up! amazing video!, Subscribed looking forward to more content.

[techgod]

it's shown as 1.57bn$ is the initial premium insurer is expecting and then 4.2bn$ that insurer is expecting in premiums after cds rate rises but how is 2.5bn$ ackman's profit as the contract buyer now has to pay 4.2bn$ to insurer after purchasing 4.2bn$ contract from Ackman. Isn't it like double payment where paying ackman and again paying insurer
Can someone plz explain me