Celebrity fund manager and activist investor Bill Ackman just sold 10% of his investment management company in a deal that valued Pershing Square at $10.5 billion. An initial public offering could come as soon as next year, the Wall Street Journal has reported.
The valuation amounts to about 64% of the $16.3 billion in assets Pershing Square is said to manage. That compares with market capitalizations of 15% to 18% of assets under management for the four public hedge-fund-style managers valued by the market at more than $10 billion: Blackstone Inc., KKR & Co., Ares Management Corp. and Blue Owl Capital Inc. Traditional public asset management companies such as BlackRock Inc., Bank of New York Mellon Corp., Ameriprise Financial Inc., T. Rowe Price Group Inc., Northern Trust Corp. and Franklin Resources Inc. have ratios from under 1% to about 4%.
Before thinking about how Ackman talked some deep pockets into that valuation, let’s consider the Finance 101 theory of asset manager valuation. We teach two simple theories to aspiring financial professionals — that managers should sell for 0% of AUM and 100% of AUM.
Before you snort in disgust at ivory-tower academics, consider the story of French entomologist Antoine Magnan, who wrote in 1934, “I applied the laws of air resistance to insects, and I arrived with Mr. St Lague at the conclusion that their flight is impossible.” This entered into popular culture as the claim that scientists think bumblebees can’t fly. But Magnan was actually calling attention to deficiencies in the understanding of aerodynamics. Modern finance professors use the simple theories to force students to think about the asset management business.
The 0% valuation is based on the legal theory that asset managers have a fiduciary duty to act in the best interests of their investors. This is why John Bogle, the founder of Vanguard Group Inc. and the most fair-minded person I ever knew, gave ownership of the company to its fund investors. Any excess value of the business, above salaries and expenses, belonged to investors, not managers. Although he benefited individual investors more than any other person in history, he died with a reported $80 million net worth — comfortably wealthy, of course, but Citadel Securities’ Ken Griffin earned as much every week in 2022.
If an asset management company is privately owned by its managers, then its value can be considered compensation for their services. There’s no reason for a fiduciary to work for nothing, or for less than his or her market worth. But if there is excess value beyond what is needed to attract and retain talent, that should belong to investors. The fund should cut fees until the market value to a third-party acquirer — one not delivering services to fund investors — is zero.
The 100% valuation proceeds from mathematical rather than legal principles. While individual managers often lose assets under management, the asset management industry as a whole always seems to get more contributions than redemptions. If you assume that remains true in the future, any positive management or performance fee, however small, has a present value equal to the value of the assets being managed.
To see that, think of the asset management industry as having a giant pile of assets. Investors are constantly putting new money in and taking money out, but there is always a net addition. The managers take, say, 2% of the asset value every year. The asset values go up and down, but the managers are the only group taking net money out. Therefore, the managers have the full economic value of the assets.
The Wall Street Journal reported that Ackman told investors to compare Pershing Square to managers such as Brookfield Asset Management Ltd. and Blue Owl, suggesting he is planning to at least quadruple assets under management to bring his valuation in line with them. This is marketing the investment like a venture company rather than an asset manager. From this perspective, it’s not the fees generated that are the draw but his acumen in building a new business. An entrepreneur is entitled to sell her business ideas and future efforts for as much as the market will bear, she has no fiduciary duty to return excess value to investors.
Can Ackman succeed? Is Pershing Square an IPO that should interest investors? There’s certainly plenty of room for asset growth, quadrupling AUM would put the firm at about 250th among global asset managers, and Ackman has just received approval for a new type of investment vehicle that could prove popular with retail investors — especially given his recently expanded profile in the news and on social media. Presumably by the time of the IPO, Ackman will have introduced this and other new products and will be able to show promising growth.
On the negative side, all asset managers are facing fee compression, and Ackman’s expansion plans seem to involve vehicles where investors expect much lower fees than hedge funds can charge. Pershing Square might not qualify for hedge-fund valuation ratios around 16%, but perhaps the 4% of premium traditional managers — meaning he’ll need to grow assets to over $250 billion, putting him among the top 100 global asset managers. And that’s just to break even by IPO time — to make substantial profits for investors he’ll need even more growth.
The months from now until the IPO should bring a lot of new information, and the prospectus should supply even more. But it seems likely that IPO investors will require a high level of both marketing success and good performance to see their investment flourish. Ackman is riding high in both categories at the moment and has hit his share of performance home runs since 2004. But let’s not forget that he’s also grounded into a few double plays such as Herbalife Nutrition Ltd. and Valeant Pharmaceuticals International Inc.
Aaron Brown is a former head of financial market research at AQR Capital Management. He is also an active crypto investor, and has venture capital investments and advisory ties with crypto firms.