Star hedge fund manager Bill Ackman’s ongoing efforts to protect Pershing Square (PSH ) from rises in long-term inflation contributed to the $10.7bn (£8.4bn) US equities fund underperforming in the first half of the year.

The FTSE 100-listed investment company generated a total underlying investment return of 10% in the six months to 30 June, trailing the US stock market with the S&P 500 index gaining 16.9%.

Shareholders, however, only received a 5.4% return as the shares’ discount to net asset value (NAV) widened to 36.1%, prompting the board to buy back a further $55.4m of shares.

The company has now bought back nearly $1.2bn of its shares since May 2017 without any improvement in the discount, which broker Numis Securities continues to regard as ‘excessively wide’ given PSH’s impressive long-term performance.

Despite the first-half setback, the closed-end fund remains well ahead of the S&P 500 in the five-and-a-bit years since Ackman re-focused his attention on investment rather than growing his business. Since March 2018 up to 30 June, PSH’s total 278% return on net assets has provided a compound annual return of 28.1% versus the US benchmark’s 84% total return and 12.1% annual compound.

The latest five-year shareholder returns of 168.5% at Friday’s close trounce the S&P 500’s 67% return and dwarf the performance of other London-listed North America equity funds which have generated an average of just 45.9%, according to Numis data.

The outsized returns have largely come from Ackman’s highly successful macro-economic hedging trades which generated more than $5bn of gains to shield the fund from the pandemic crash in 2020 and correctly cushioned it against the onset of higher inflation at the end of that year.

Put right

The manager’s preoccupation with inflation proved more difficult in the first half of this year, however. Put options (with which Ackman is short-selling 30-year US government bonds, or treasuries) knocked 4.1% off the investment company’s returns, although this was more than offset by Mexican restaurant chain Chipotle (CMG.N), whose 14% weighting added 7% to returns after menu changes saw its shares rally by a third this year.

Alphabet (GOOGL.O), the Google and Youtube owner that Ackman added to the portfolio in May, was the second biggest contributor to performance after bouncing back from a selloff based on erroneous fears over artificial intelligence (AI). This added 2.9% to returns and made the tech giant PSH’s fifth-biggest holding at 12.6% of assets.

However, Alphabet’s contribution was largely negated by a 2.1% hit to NAV caused by Universal Music Group (UMG), PSH’s largest position at nearly a quarter of assets. It suffered on short-term fears that its business would suffer from AI-generated songs.

Inflation will surprise

Ackman said the interest rate hedging strategy, which generated a net $2.3bn last year, had cost the fund some performance in the first half as long-dated treasuries rose in value on fears of a recession after the US regional banking crisis in the spring.

He was confident this would reverse with the price of 30-year US government bonds already coming under pressure since April, making his put options profitable, arguing long-term inflation was set to rise beyond market expectations.

The manager forecast the yield on 30-year treasuries, which moves in the opposite direction to their price, could hit 5.5%, substantially higher than the 4.3% which it has reached with a 0.7% advance in three months.

Ackman based his estimate on US inflation stabilising at 3%, above the Federal Reserve’s target of 2%. This would require higher-for-longer interest rates that in addition to hitting bond holdings, would hurt corporate profits and justify his hedging trade whose gains would offset potential declines in his 10 core, long-term equity positions.

‘Investors have become so accustomed to low long-term rates for many years that 4.3% seems like a high long-term rate for many fixed income investors,’ Ackman wrote. ‘We do not believe that current levels of long-term treasury rates are high considered in a longer-term historical context, and when one does the math on what long-term rates must be for investors to earn an adequate long-term, risk-free return in excess of inflation.’

He added: ‘We believe that emerging structural forces including higher defence spending, energy scarcity and the transition to green energy, deglobalisation, and the increased bargaining power of labour will likely contribute to sustained longer-term inflationary pressures.’

Separately, Ackman was confident that US regulators would approve his plan for a special purpose acquisition rights company (Sparc) that would give PSH shareholders exposure to buying a target company without having to tie up their capital.