Stocks are little changed on Friday afternoon, with the benchmark S&P 500 (^GSPC -1.79%) and the Dow Jones Industrial Average (^DJI -1.40%) (DJINDICES: $INDU) down 0.19% and 0.03%, respectively at 3:20 p.m. EDT. "Little changed" does not apply to shares of Herbalife Ltd (HLF -1.02%), which are up 9.6%. The nutritional supplements network marketing company announced that it has reached a settlement agreement with the Federal Trade Commission in regard to its multiyear investigation, which is now complete.
With today's Herbalife announcement, billionaire hedge fund manager Bill Ackman's annus horribilis just got worse. Ackman's Pershing Square Capital Management has a very sizable short position betting against Herbalife and has led a very public campaign against the company going back to 2012.
Ackman is a talented investor and he's very intelligent (too much so?), but Herbalife is an excellent example of just how challenging that type of high-profile, confrontational -- even conflictual -- investing is. The difficulty is that it's not a matter of intelligence, but of psychology.
Leading a short campaign against a company requires an unusual amount of confidence -- particularly if you are pitted against a talented and supremely successful investor like Carl Icahn. (Icahn currently owns 18.3% of Herbalife's outstanding shares. Along with news regarding the FTC's investigation, the company announced that it has agreed to allow Icahn to increase his ownership stake to 34.99%.) But trying to ensure you don't veer into overconfidence -- even simply recognizing where the difference lies -- is an extraordinarily tricky balancing act. All the more so for someone like Ackman, who owes much of his success to that confidence.
Furthermore, you're taking a very public contrarian position and you may be the subject of a countercampaign by the company. In this case, Herbalife created a website, TheRealBillAckman.com, complete with numerous critical videos.
Under those circumstances, there is an enormous risk that your view on the investment will calcify as a natural reaction to the opposition you encounter, leaving you with less flexibility to revisit that view in light of new evidence.
This is a risk that Michael Burry, one of the main characters in Michael Lewis' The Big Short understood. As Lewis writes:
In October 2005, in his letter to investors, Burry finally came completely clean and let them know that they owned at least a billion dollars in credit default swaps on subprime mortgage bonds. [Note: this is a bet against the housing market]... When his investors learned that their money manager had actually put their money directly where his mouth had long been, they were not exactly pleased...
Inadvertently, he'd opened up a debate with his own investors, which he counted among his least favorite activities. "I hated discussing ideas with investors," he said, "because I then become a Defender of the Idea, and that influences your thought process." Once you became an idea's defender you had a harder time changing your mind about it.
It appears this is what Ackman became -- a "Defender of the Idea." Here is some of the evidence:
In 2012, Ackman told Bloomberg, "This [Herbalife] is the highest conviction I've ever had about any investment I've ever made."
The following year, in an interview with CNN, he said (emphasis added):
I'm going to the end of the earth [with the campaign against Herbalife]. If the government comes out and determines this is a completely legal business, then I will lobby Congress for them to change the law. I had a moral obligation. If you knew that Bernie Madoff was running a Ponzi scheme, and you didn't tell anyone about it, and it went on for 33 years...
That sounds more like a crusade than an investment. In fact, in 2014, Ackman told CNN that he would continue to pursue Herbalife personally even if he ultimately exited the position unsuccessfully.
Finally, last year, he told CNBC (emphasis added):
I've never done better research on a company in my career in terms of the quality of the work that the firm has done, all the work that we've done. I'm 100% confident in my thesis on Herbalife.
100% confident? No investor should ever be 100% confident in their thesis for any investment. No one is omniscient; investing is a game of probabilities, not certainty.
You might counter that Ackman himself doesn't believe it and is only saying that to project confidence. Perhaps, but I'd then suggest that, even if that is the case, saying something like that publicly is a mistake, because it's a form of commitment and is the first step on the path to believing it.
Digging his heels in has paid off in the past for Ackman: He made over a billion dollars after a six-year short campaign against mortgage insurer MBIA. In the case of Herbalife, it has proved to be the wrong course of action. Still, he will walk away from the experience a bit wiser and, presumably, a better investor. When he was asked if he would consider leading a similar campaign against another company in the future, he responded:
I don't know that I'm going to do another one of these [short campaigns like Herbalife]. It could be my last because the rewards are probably not great enough to justify the time and the energy that we've put into this and also people always... they hate short-sellers.
He's right about that.
Tweet of the Day
Journo: Given recent data is FOMC likely to hike?— Mark Dow (@mark_dow) July 15, 2016
A: If current data continue a hike might be appropriate.
Headline: FED SAYS HIKE IN SEPT