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August 13, 2014 Dear Pershing Square Investor: The Pershing Square funds outperformed the major market indexes for the first and second quarters of 2014 and since inception as set forth below
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:
For the QuarterFor the QuarterYear to DateJanuary 1 - March 31April 1 - June 30January 1 - June 30Since Inception
Pershing Square, L.P.
01/01/04 - 06/30/14 Gross Return13.8%16.1%32.1%1199.1% Net of All Fees10.7%12.9%25.0%626.7%
Pershing Square II, L.P.
01/01/05 - 06/30/14 Gross Return13.7%15.8%31.7%788.1% Net of All Fees10.7%12.6%24.6%437.1%
Pershing Square International, Ltd.
01/01/05 - 06/30/14 Gross Return14.3%15.9%32.5%650.4% Net of All Fees11.1%12.8%25.3%365.9%
Pershing Square Holdings, Ltd.
12/31/12 - 06/30/14 Gross Return14.1%16.0%32.3%49.6% Net of All Fees11.5%13.4%26.4%38.5%
Indexes (including dividend reinvestment)
01/01/04 - 06/30/14 S&P 500 Index1.8%5.2%7.1%118.8% NASDAQ Composite Index0.8%5.3%6.2%144.0% Russell 1000 Index2.0%5.1%7.3%127.4% Dow Jones Industrial Average-0.2%2.8%2.7%110.3%
Reflections After Ten Years
We began investing capital January 1
st
, 2004 in partnership with a subsidiary of Leucadia National Corporation which invested $50 million in Pershing Square, L.P. at our launch. At the time of
Leucadia’s
investment, Gotham Partners did not have regulatory closure with respect to the
SEC’s
and New York Attorney
General’s
MBIA-related investigations.
Leucadia’s
investment, and most importantly, its imprimatur were critical to the successful launch of the
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Past performance is not necessarily indicative of future results. All investments involve risk including the loss of principal.
Please see the additional disclaimers and notes to performance results at the end of this letter.
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firm. We will forever be indebted to Ian Cumming and Joe Steinberg, then Chairman and CEO of Leucadia, who backed us when few others would. As a thank you gesture at the time, we offered Leucadia a substantial minority interest in the management company for no additional consideration, but they asked for nothing but good investment results in exchange for their investment, and for that we are very grateful.
Returns Since Inception
Over the last ten and one-half years, we have generated net returns to our investors of 626.7% or 7.3 times day-one investor capital. Over the same period, the S&P 500, our principal benchmark, as it has historically comprised most of our holdings, has returned 118.8% or about 2.2 times. Expressed as a compounded annual return, the funds have returned 21% net per annum versus 8% for the S&P 500
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. In a world in which investors are pleased to earn returns that are one or two percentage points per annum above the S&P over 10-year periods, our approximate 13 percentage point annual net margin over the index is notable. We are proud of our record and how that record has been achieved. While our returns have been strong, our downward volatility (the only kind of volatility investors really care about) has been minimal. We have had two negative years in our history, 2008 when the funds declined 12% to 13%, and 2011, when the funds declined approximately 2%. While the S&P index is by design a fully invested index, we have generated our returns with negative leverage, i.e., cash has averaged 14% of invested capital since inception. Some might therefore criticize us for the inefficient use of our balance sheet, for clearly the liquidity and nature of our holdings would have allowed us to be more invested over time. Indeed, we could have comfortably supported a modest amount of margin leverage without taking undue risk. Because we are an active, control and influence-oriented investor, we have avoided being fully invested because of the risk of investor redemptions. For example, during 2009, despite a relatively strong 2008 and a 41% net return in 2009, we had to keep a substantial portion of our assets in cash because of the large amount of investor redemptions we received. We will hopefully begin to address this issue with the initial public offering of Pershing Square Holdings, Ltd. (PSH), targeted for later this year, which will increase the amount of our capital that is permanent. Our investment performance is particularly striking when one considers our compound annual gross return of 27.7% for the past 10 and one-half years. This is a particularly large number in light of our investment universe which is comprised of the largest and most well-covered companies in the world
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large cap North American equities
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which according to the efficient market hypothesis should not offer investors above-market returns. Our returns also reflect a substantial drag from our historically large average cash position since inception. These results beg the obvious question. Have our returns been a function of good investment analysis, or have
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Returns are for Pershing Square, L.P., the Pershing Square fund with the longest track record. Past performance is not necessarily indicative of future results. All investments involve risk including the loss of principal. Please see the additional disclaimers and notes to performance results at the end of this letter.
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our results been driven by a strategy that has a unique competitive advantage? The answer, we believe, is both.
Corporate Control, Influence, and Control Premiums
Private equity investors pay large premiums for the right to control a portfolio
company’s
governance, management, competitive strategy, operating strategy, capital allocation, and the timing of exit. Despite having to pay control premiums, successful private equity investors have earned attractive returns for their investors. The fact that opportunities exist for private equity investors to pay substantial premiums and earn high returns is evidence that the companies that they have acquired were not optimally managed and/or capitalized at the time of purchase. If an investor can effect corporate change without having to pay a control premium
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or better, buy at a discount due to shareholder dissatisfaction
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that investor would have an extraordinary advantage. A rational investor is unlikely, however, to sell control at a discount. The good news is that on occasion, minority stakes in high quality businesses can be purchased in the public markets at a discount. These discounts principally arise because of two factors: shareholder disaffection with management, and the short-term nature of large amounts of retail and institutional investor capital which can often overreact to negative short-term corporate or macro factors. Such an environment creates an opportunity for the proactive investor to buy a minority stake in a public company and work to effect corporate change to create value on behalf of all shareholders.
Why Shareholder Activism is Good for Corporate America
Activist investing is inherently healthy for the markets, particularly in a world where the substantial majority of investment capital is indexed, in ETFs, or is explicitly or implicitly passively managed. Prior to the arrival of shareholder activism, when shareholders were disappointed with management, they had no choice but to sell because they had little if any recourse. Today, they call a shareholder activist. While not all shareholder activists have long-term, shareholder-oriented agendas, only those that do are likely to have substantial influence because the activist can only succeed with majority shareholder support. While the advisors to entrenched management teams have attempted to limit the impact of activists with poison pills with decreasingly lower thresholds and attempts to change the 13D rules, non-activist institutions have aggressively pushed back as they recognize that shareholder activism is one of the few means they have to unlock value in a long-term underachieving company. The popularity of activism as a strategy has increased due to the potential it offers for substantial returns. In light of the attractive returns achieved and the growing number of participants, we are often questioned about the sustainability of our strategy in an apparently more competitive environment. The good news is that the opportunities for shareholder activism are only limited to the extent all corporations optimize their business models, operations, and capital allocation and become efficiently priced by the markets. We believe that corporate inefficiency and security mispricing will continue for the foreseeable future and present a continued rich opportunity set for Pershing Square. In light of our
strategy’s
high degree of concentration, our
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