In his Pershing Square 2024 Interim Report, Bill Ackman highlights the increasing dominance of index funds, which act as permanent owners, in stock market capitalization. This shift amplifies the influence of short-term, highly leveraged investors, such as market-neutral and quantitative funds, on price discovery.
These investors often use margin, derivatives, and leverage, leading to heightened stock price volatility when companies miss earnings or macroeconomic data surprises occur.
While this volatility impacts short-term market performance, Ackman views it as beneficial for long-term investors, providing opportunities to acquire undervalued, high-quality companies at attractive prices when the market overreacts to temporary setbacks.
Here’s an excerpt from the letter:
The stock market has increasingly been characterized by a growing percentage of the market capitalization of companies being held by effectively permanent owners, principally index funds.
We believe that the growing index ownership as a percentage of stock market float has increased the impact that short-term, highly leveraged investors can have on price discovery as they now comprise a growing percentage of the market cap and daily trading of companies, and are important marginal buyers and sellers of a security.
These shorter-term investors – which include so-called market-neutral and quantitative funds – use large amounts of margin, derivative, and total return swap leverage in their strategies.
As highly leveraged market participants, these investors’ tolerance for mark-to-market losses is small, which contributes to stock price volatility as they can become effectively forced sellers when companies disappoint, even in the short term.
Equity markets have exhibited an enormous amount of single-name stock price volatility for even the largest companies when they surprise investors with even minimally below-expectation overall results or small misses on certain closely followed business metrics, with Universal Music Group being one such example in our portfolio. Markets are also exhibiting an enormous amount of volatility when macro data surprises occur.
Greater stock market volatility is the long-term friend of the active investor with permanent capital who seeks to identify high-quality companies which are not dependent on the capital markets to implement their business strategies.
While an earnings’ miss or other business metric disappointment in a quarter could reflect the beginning of deterioration in fundamentals, in many cases the impact of the disappointment has only a marginal effect on long-term intrinsic value.
Pershing Square has been a large, long-term beneficiary of market overreactions to short-term bad news as they can drive business valuations to levels well below long-term intrinsic value, and create buying opportunities coupled with a high degree of liquidity.
You can find a copy of the report here;
Pershing Square 2024 Interim Report
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