Bill Ackman Bonds: A $2.6 Billion Bet Against the Market

Bill Ackman, a well-known hedge fund manager, has made a significant bet against the market by investing $2.6 billion in bonds.

He's not just any ordinary investor, as his firm, Pershing Square Capital Management, has a history of taking bold positions in the market.

This particular bet involves a massive portfolio of bonds, which is a relatively unusual move for a hedge fund of Ackman's size and reputation.

Ackman's investment is a testament to his confidence in his research and analysis, which has guided his decisions throughout his career.

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Bill Ackman's trades are a testament to his risk-taking abilities and market insights. He's a master of navigating complex market conditions.

Ackman turned $27 million into $2.7 billion in just 30 days by betting against the US market's reaction to COVID. This was a bold move, considering the uncertainty surrounding the pandemic.

Ackman considered liquidating all his assets into cash but decided to buy credit default swaps (CDS) on corporate bonds instead. This move allowed him to protect his assets from negative market movements.

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The CDS contract required Ackman to pay $27 million every month for 5 years, which translates to $324 million annually. This premium rate was 0.5% on corporate bonds before COVID caused a spread widening.

By dividing the annual premium by the CD insurance rate, we find that Ackman was buying protection on around $64.8 billion worth of bonds. This is a staggering amount, equivalent to about 1% of the entire US market's investment-grade bonds.

Ackman's next big short involves betting against long-dated US bonds due to his expectation of persistent 3% global inflation. He believes this scenario is not reflected in bond prices, which currently yield 4.25% for the 30-year Treasury bond.

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Rising interest rates have a direct impact on bond prices, causing them to fall as new bonds with higher interest rates come to market. This inverse relationship between bonds and interest rates makes investing in bonds a bit tricky.

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The severity of the price drop is determined by a bond's duration, which calculates the potential decrease in value when rates rise. Bonds with longer maturity timelines will have higher durations and fall by more than shorter ones.

Most investors want the higher coupon offered by new bonds, leading to a desire to sell existing bonds, further driving down their price.

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CDS premiums and spreads are a crucial aspect of the bond market. CDS prices are represented in basis points (bp), with 1 basis point equivalent to 0.01%.

A basis point is a small percentage, but it can add up quickly. For example, a spread of 300 bp means you'd have to pay 3% of the debt value as a fee to protect against defaults.

Tightening credit spreads are a good sign, indicating that corporate creditworthiness is increasing and the economy is healthy. This is because investors believe companies are more likely to pay back their debts.

Widening credit spreads, on the other hand, signal unhealthy business conditions. This makes CDSs more valuable, as you can sell and make a profit from the difference between the original and wider spreads.

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Economic data is starting to slow, with consumers stepping away, jobs growth slowing, and manufacturing contracting.

Consumers are getting more cautious, which is a sign that the economy might be heading for a slowdown, not a recession.

The Fed has plenty of room to cut rates, which would send 30-year prices surging if things start to get bad or below an acceptable level of growth.

Rate cuts often happen after the Fed pauses multiple times in a period, and we've already seen two pauses this year.

Historically, this pattern has played out, so it's possible that we'll see rate cuts in the near future.

Bill Ackman's strategy for shorting bonds is centered around his belief that yields on the 30-year Treasury bond will continue to rise. He expects yields to climb to 5.5% due to higher inflation rates.

Ackman's short thesis is based on his expectation of higher inflation rates, which he believes will remain above the Fed's target of 2%. He sees inflation persisting at 3% or higher for the long term.

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The hedge fund manager points to structural changes that will keep inflation elevated, including increased government spending on entitlements and higher negotiating power of unions. He also expects a reversal of the globalization trend and a shift to electric and renewable energy systems.

Ackman sees an imbalance in the supply versus the demand for Treasuries, with Treasury supply rising to meet demand from large deficits and a ballooning national debt. The national debt has risen by $1 trillion alone in the last month to $33 trillion.

The combination of quantitative tightening and higher supply will lead to higher market yields, according to Ackman. He believes the Fed's policy shift from zero-rate-interest-policy to quantitative tightening will keep rates high for a long time.

Ackman's expectation of higher inflation rates and yields is not unfounded, as we saw in the 1970s when inflation persisted for much longer and stayed higher than expected.

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Bill Ackman paid $27 million per month for 5 years, which would amount to $1.62 billion in total premiums paid if he had held on for that long.

The treasury rate was 1.5% for 30-year Treasury bonds, which would have discounted the total amount to about $1.56 billion.

Treasury bonds are considered risk-free because they are backed by the US government, which is widely believed to never be able to default.

The 30-year Treasury bond offered a higher yield due to its longer time span, making it the option that yielded the highest return without any risk.

Bill Ackman's CDS contract premiums were more or less equal to the prevailing credit spreads for the bonds being protected against, at 0.5% of the notional amount per year for 5 years.

He bet on credit spreads widening as a result of COVID damaging corporate creditworthiness, which they did, increasing from 0.5% to 1.35% or 50 bp to 135 bp.

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The yield on the 30-year bond is too low due to persistent inflation and the Fed's "higher for longer" stance, making it a good opportunity to go short on these bonds.

Shorting these bonds can result in plenty of profits for investors, especially with the help of ETFs, making it easy to follow Ackman's lead.